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IFRS – Leases NewsletterFebruary 2010, Issue 1

This IFRS Leases Newsletter highlights key developments relating to the joint International Accounting Standards Board (IASB) and US Financial Accounting Standards Board (FASB) Leases project, including the results of recent IASB and FASB discussions, the expected key impacts for lessees and lessors and an example of the proposed lessor accounting model.

Contents

1. Projectoverview 12. Keyimpacts 23. Currentstatus 44. FASB/IASBdifferences 95. Lessoraccountingexample 96. Nextsteps 11

KPMG’s update on the joint IASB/FASB Leases project

1. Project overviewIn this project, the IASB and FASB (together the Boards) aim to respond to longstanding criticisms that lease accounting has been too permissive of off-balance sheet treatment by lessees, overly complex and dominated by arbitrary rules. The Boards propose to eliminate the requirement to classify a lease as an operating or finance lease and instead propose a single lease accounting model for all lessees and lessors, with some exceptions.

The Boards issued a joint discussion paper (DP) in March 2009 on accounting for leases by lessees. Since that time they have redeliberated a number of issues and debated proposals for accounting by lessors. The Boards plan to issue an exposure draft (ED) of a new lease accounting standard in mid 2010 and a new accounting standard in mid 2011.

The Boards’ proposals for lessees focus on the right-of-use model, in which the lessee recognises an asset for its right to use the leased asset and a liability for its obligation to pay rentals.

The Boards’ tentative decisions regarding lessor accounting focus on the performance obligation model, in which the lessor continues to recognise its interest in the underlying leased asset, and recognises a new asset for its right to receive rentals and a


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corresponding liability for its obligation to deliver the use of the leased asset to the lessee.

Proposed models for lessee and lessor accounting

Recogniseright-of-use

asset

Recogniseliability for

obligation topay rentals

“Right to use”leased asset

Performanceobligation model

Right-of-usemodel

Lease rentals

Lessor Lessee

Recogniseleased asset

+right toreceiverentals

Recogniseliability forpermitting

use ofleasedasset

2. Key impactsThe key impacts of the proposals are set out below from the perspective of lessees and lessors.

2.1 LesseeLessees, particularly those with leases currently classified as operating leases, likely will find the proposals have the greatest impact, in particular on their statement of financial position. The proposed requirement to recognise additional assets, liabilities and financial expense are likely to impact key performance ratios, such as tangible asset ratios and debt/equity ratios, and consequently the ability to satisfy debt covenants. Entities currently renegotiating debt arrangements may wish to consider whether flexibility in determining appropriate debt covenants can be obtained to minimise the impact of the new leases standard when it becomes effective.

LeasescurrentlyclassifiedasoperatingleasesLessees with leases currently classified as operating leases would recognise those leases “on-balance sheet” in a manner similar to the IAS 17 Leases finance lease model, with recognition of a “right-to-use” asset and a liability to pay rentals. However, the proposed measurement model for the asset and liability is different than the existing IAS 17 finance lease requirements, particularly regarding options and contingent rentals (see below).

LeasescurrentlyclassifiedasfinanceleasesLeases currently classified as finance leases that are “in-substance purchases” would be recognised as purchased assets with an associated financial liability and would not be in the scope of the leases standard. Those leases remaining within the

leases standard would be measured on a different basis than the existing IAS 17 requirements. For example, the proposed requirements regarding options and contingent rentals are likely to increase significantly the carrying amounts of the asset and liability recognised in some cases. However, the unguaranteed residual is not included in the proposed lease receivable, so the impact of moving from IAS 17 would depend on specific facts and circumstances.

2.2 LessorLessors will find the proposed performance obligation model significantly different than the existing IAS 17 requirements, regardless of whether leases are classified currently as operating or finance leases.

LeasescurrentlyclassifiedasoperatingleasesLessors holding leases currently classified as operating leases would recognise, in addition to the underlying leased asset, an additional asset being the right to receive rental payments, and an additional liability, being the obligation to deliver use of the underlying leased asset. It is not

yet clear whether these new assets and liabilities would be presented net or gross. In addition, although it is not yet clear how they would be presented, in the statement of comprehensive income a lessor would recognise interest income on the additional asset, income on the amortisation of the additional liability, and depreciation of the underlying leased asset.

LeasescurrentlyclassifiedasfinanceleasesLeases currently classified as finance leases that are “in-substance sales” would be excluded from the leases standard; the lessor would recognise a sale of the leased asset with an associated financial asset. For those leases remaining within the leases standard a lessor no longer would derecognise the underlying leased asset and recognise a finance lease receivable. Instead, the lessor would continue to recognise the underlying leased asset, and also would recognise an additional asset being the right to receive rental payments, and an additional liability being the obligation to deliver use of the underlying leased asset. It is not yet clear whether


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these new assets and liabilities would be presented net or gross. The requirements regarding options and contingent rentals are different than those in IAS 17 and are likely to increase the carrying amounts of the asset and liability recognised. However, the unguaranteed residual is not included in the proposed lease receivable, so the impact of moving from IAS 17 would depend on specific facts and circumstances.

2.3 Potential exceptions – investment propertyThe Boards have debated a number of potential exceptions to the above models, notably a potential scope exemption for lessors of investment property.

The IASB has agreed tentatively that a lessor that follows the cost model for investment property should apply the proposed performance obligation model. However, a lessor that follows the fair value model for investment property would not apply this model and would continue to apply IAS 40 Investment Property.

US Generally Accepted Accounting Principles (GAAP) do not permit fair value measurement for investment property at present unless the reporting entity qualifies for fair value measurement of its investment assets in accordance with specialised industry accounting requirements. The FASB is to consider whether to permit or require a fair value model for investment property for reporting entities that do not qualify for fair value measurement of their investment assets in accordance with specialised industry accounting requirements.

Comparison of proposals with existing requirements

Operating lease Finance lease Proposed model

Lessee - statement of financial position

Off-balance sheet Leased assetFinance lease

liability

Right-of-use asset

Liability to pay rentals

Lessee - statement of comprehensive income

Rental expense Asset depreciation

Finance expense

Asset amortisation

Finance expense

Lessor - statement of financial position

Underlying leased asset

Finance lease receivable

Underlying leased asset

Receivable for rental payments

Liability to deliver use of asset

Lessor - statement of comprehensive income

Asset depreciation

Rental revenue

Interest revenueManufacturer/

dealer selling profit (if any)

Asset depreciation

Interest revenueAmortisation of

liability


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3. Current statusThe status of the leases project at 31 January 2010 and key decisions made to date are outlined in the table below.

Items marked with “#” represent a change from the DP proposals made by the IASB.Items marked with “*” represent a change from the DP proposals made by the FASB.

Topic Tentative decision – lessee Tentative decision – lessor

Scope – identification of leases

Based on definitions and scope of existing IAS 17.

KPMG observation We believe that the scope of any new leases standard should be reconsidered with the focus on development of clear principles and criteria to distinguish service (executory) contracts from contracts that convey the right of use.

Scope – exclusions Leases involving the following would be excluded from the proposed leases standard:#*

¬¬ intangible assets (except those right-of-use intangibles recognised under the leases standard);¬¬ natural resources, such as minerals, oil and natural gas; and¬¬ biological assets.

In-substance purchases are not in the scope of the new leases standard.#*

A simplified model would be permitted for short-term leases, i.e. leases with a maximum possible lease term of less than 12 months. Under this simplified model the lessee would recognise in the statement of financial position a right-of-use asset and a liability equal to the undiscounted value of the lease payments.#*

Leases of non-core assets are within scope.

KPMG observation The decision to exclude leases of intangible assets appears to be for expediency in completing the project and we expect that these exclusions may not be permanent. We expect that a second phase of the project may address more fully whether these assets should be included.

There is tension between the objective to have a single lease accounting model and the decision to exclude in-substance purchases; similar to the manner in which operating and finance leases are distinguished currently, it will be necessary to make a binary distinction between two different types of lease transaction.

Regarding short-term leases, whilst the proposed lease accounting model may be difficult to apply to multiple short-term low-value lease arrangements, any exclusion for short-term leases might be arbitrary, difficult to apply in practice, and may open the possibility for structuring. In addition, the assets and liabilities that arise from short-term leases may be significant in aggregate for an entity that enters into many short-term leases in the normal course of its business.

Scope – investment property leases

Such leases would be in the scope of the new leases standard.

For entities reporting under International Financial Reporting Standards (IFRS), the new leases standard would apply only to lessors that use the cost model for measuring investment property; lessors that measure investment property at fair value through profit or loss would not be required to apply the new leases standard. The FASB plans to consider leases of investment property further.#*


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KPMG observation The IASB’s decision to exempt leases of investment property measured using the fair value model is likely to be welcomed by those in the real estate community who feel that the proposed lease accounting model did not provide a useful description of the nature of their business.

US GAAP currently does not permit fair value measurement of investment property unless the reporting entity qualifies for fair value measurement of its investment assets in accordance with specialised industry accounting requirements. This area previously was identified as a potential short-term convergence project.

Accounting model Right-of-use model under which the lessee recognises:

¬¬ an asset representing the right to use the underlying leased asset for the lease term;

¬¬ a liability for the obligation to pay rentals; and

¬¬ amortisation of right-to-use asset and finance expense arising on liability.

Options and contingent rentals are not accounted for separately as components and are discussed further below.

Performance obligation model under which the lessor recognises:

¬¬ the underlying leased asset;¬¬ an asset representing right to receive rental

payments;¬¬ a liability representing obligation to deliver

use of its asset; and¬¬ revenue over the lease term.

Options and contingent rentals are not accounted for separately as components and are discussed further below.

KPMG observation The leases proposals require a separate (gross) presentation of the right-of-use asset and the liability for the obligation to pay rentals. This contrasts with the revenue recognition proposals, which would permit a “net contract” presentation of the assets and liabilities arising from other types of contracts.

The Boards included two alternative accounting models for lessors in the DP: the performance obligation model and the derecognition model. The derecognition model appears to be closer in spirit to the Boards’ proposals on other projects regarding revenue recognition and derecognition of financial instruments.

The performance obligation approach is significantly different than the current treatment of finance leases by lessors.

Timing of initial recognition

Assets and liabilities would be recognised when the contract is signed.

Until the leased asset is delivered to the lessee, the net contract asset or liability would be measured at cost.#*

KPMG observation Recognition of the contract asset and liabilities “net” prior to delivery of the leased asset is consistent with other forward contracts and also is consistent with the current revenue recognition project decisions.

Initial measurement – liability

Present value of the lease payments would be discounted using the:

¬¬ lessee’s incremental borrowing rate; or¬¬ interest rate implicit in the lease if readily

determinable.#*

Transaction price, being present value of the lease payments, would be discounted using the interest rate implicit in the lease.

Lease term and payments would take into account options to extend, terminate or buy the underlying leased asset, contingent rentals and residual value guarantees, as discussed in more detail below.


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KPMG observation Although the obligation to pay rentals is a financial liability, the measurement requirements are not consistent with IAS 39 Financial Instruments: Recognition and Measurement or IFRS 9 Financial Instruments. Permitting the interest rate implicit in the lease enables the specific circumstances of a lease, including the structured financing of the arrangement or tax benefits inherent within the return agreed between the lessee and the lessor, to be reflected.

The measurement requirements are consistent with the right-of-use asset recognised by the lessee, except that the incremental borrowing rate would be the preferred discount rate for the lessee.

One implication of recognising the lease liability and lease asset at the same amount is that there no longer would be upfront revenue recognition for manufacturer or dealer lessors that enter into leases that are not in-substance sales.

Initial measurement – asset

Cost, represented by:

¬¬ present value of the lease payments (effectively the liability amount); and

¬¬ initial direct costs.#

Cost, represented by the:

¬¬ present value of the lease payments discounted using the interest rate implicit in the lease; and

¬¬ initial direct costs.#

Lease term and payments would take into account options to extend, terminate or buy the underlying leased asset, contingent rentals and residual value guarantees, as discussed in more detail below.

KPMG observation The capitalisation of initial indirect costs would not be consistent with the requirements for transaction costs in IFRS 3 Business Combinations (2008).

Although the right to receive rentals is a financial asset, the initial measurement requirements are not consistent with IAS 39 or IFRS 9.

The measurement requirements are consistent with the lessee’s right-of-use asset, except that the incremental borrowing rate would be the preferred discount rate for the lessee.

The capitalisation of initial direct costs is not consistent with the requirements for transaction costs in IFRS 3.

Subsequent measurement – liability

The Boards have proposed the following for subsequent measurement of the liability to pay rentals:

¬¬ recognise based on amortised cost using the effective interest method;

¬¬ no reassessment for a change in the incremental borrowing rate; and#

¬¬ measurement of the liability at fair value would not be permitted.

Decreases in the obligation to deliver use of the leased asset would be recognised as revenue.

The impact of changes in assessment of options to extend, terminate or buy the underlying leased asset, contingent rentals and residual value guarantees is discussed in more detail below.


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KPMG observation We support not reassessing changes in the incremental borrowing rate, as the original borrowing rate determined at the inception of a lease contract represents the cost to the entity of that particular lease.

It is not clear why measuring the liability at fair value is prohibited, when, at least notionally, the right-of-use asset may be fair measured at fair value subsequently.

We expect that the current concerns of lessors regarding straightlining of rental expense/revenue for operating leases will continue. Generally it will be difficult to argue that a systematic revenue recognition method other than straightline will be representative of the way the lessor delivers the use of the underlying leased asset to the lessee.

It is not yet clear whether revenue would be classified as “rental revenue” or “amortisation of lease obligation”.

Subsequent measurement – asset

The Boards have proposed/decided tentatively the following for subsequent measurement of the right-of-use asset:

¬¬ recognise based on amortised cost, over the shorter of the lease term or economic life of the underlying leased asset;

¬¬ disclose as amortisation, not as rental expense;

¬¬ subject to existing impairment testing requirements for non-financial assets; and#*

¬¬ revaluation subject to intangible asset requirements.#*

The lessor would measure the asset at amortised cost using the effective interest method.

The impact of changes in assessment of options to extend, terminate or buy the underlying leased asset, contingent rentals and residual value guarantees is discussed in more detail below.

KPMG observation IAS 38 Intangible Assets requires an “active market” for revaluation of intangibles.

As the right-of-use asset is likely to be very specific to an entity, revaluations are likely to be rare.

Revaluation increments are not permitted under US GAAP.

The proposal to measure the asset at amortised cost using the effective interest method broadly is consistent with the measurement bases in IFRS 9 for financial instruments and with how lessors currently account for finance leases.

However, the approach to identify and estimate the cash flows to be included in the asset is significantly different than IFRS 9 and the current finance lease model.

Options to extend or terminate the lease

The Boards have proposed/decided tentatively the following for options to extend or terminate the lease:

¬¬ recognise lease term using the longest possible lease term that is more likely than not to occur;#*

¬¬ consider all relevant factors including options to renew at market value at date of renewal and lessee specific factors (i.e. past practice and intention);#*

¬¬ reassess lease term at each reporting date (only if there has been a change in facts or circumstances); and

¬¬ changes from reassessment adjusted against right-of-use asset (lessee) or liability (lessor).


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KPMG observation We believe that determining the most-likely lease term will require a significant amount of judgement and subjectivity and inevitably will reduce comparability for users of financial statements. Our initial thoughts are that this approach will result in increased inconsistency in the determination of lease terms for lessees with similar leasing arrangements.

Contingent rentals The Boards have proposed/decided tentatively the following for contingent rentals:

¬¬ recognise using an expected outcome technique (not using every possible scenario);*¬¬ for lessors, an expected outcome technique is used only if expected outcomes can be

measured reliably;¬¬ if contingent rentals are based on index or rate, then use:

– readily available forward rates#; or otherwise– rates at inception of lease; and

¬¬ reassess if new facts and circumstances indicate material changes in the liability.#*

KPMG observation The IASB recommended in the DP that adjustments be made against the right-of-use asset, whilst the FASB recommended recognition in profit and loss. It appears that the Boards are trying to identify criteria that permit some adjustments to be recognised in profit and loss and some to be adjusted against the right-of-use asset.

The accounting for contingent rentals proposed for lessors is not consistent with that for lessees. The Boards have introduced a “reliable measurement” criterion for lessors, to be consistent with the revenue recognition project.

Residual value guarantee

The Boards have proposed/decided tentatively the following for residual value guarantees:

¬¬ recognise using an expected outcome technique (not using every possible scenario); and*

¬¬ reassess if new facts and circumstances indicate material changes in the liability.#*

To date no tentative decision has been taken on accounting by a lessor for leases that include residual value guarantees.

KPMG observation The IASB recommended in the DP that remeasurement adjustments be made against the right-of-use asset, whilst the FASB recommended recognition in profit and loss. It appears that the Boards are trying to identify criteria that permit some adjustments to be recognised in profit and loss and some to be adjusted against the right-of-use asset.

Sale and lease back If a transaction qualifies as a sale (using the existing sale and lease back guidance for the underlying leased asset), then:

¬¬ derecognise the leased asset;¬¬ recognise a right-of-use asset; and¬¬ recognise a liability for rental payments.

If a transaction qualifies as a sale (using the existing sale and lease back guidance for the underlying leased asset), then:

¬¬ recognise the leased asset;¬¬ recognise a liability to deliver use of asset;

and¬¬ recognise an asset for rental payments.

KPMG observation The interaction and possible conflict between the sale and leaseback requirements, the exclusion of purchases from the leases standard and the requirements of IAS 18 Revenue will be important. Under current IFRSs, the IFRIC clarified that IAS 17, rather than IAS 18, provides the more specific guidance on sale and leaseback transactions, i.e. the criteria to be applied to assess whether to recognise the sale leg of a sale and leaseback transaction. It will remain important to have clarity on the applicable standard given that IAS 18 is based on the transfer of risks and rewards whereas the new leases standard is likely to be based on control.


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Presentation Not yet considered in the redeliberations.

KPMG observation For lessees, the DP recommended disclosure based on the nature of the underlying leased asset; however, this has not yet been reconsidered by the Boards. Disclosure based on the underlying leased asset would be inconsistent with the recent IASB decision that revaluation of the asset is only permitted if the IAS 38 criteria are met.

Transition Recognise asset and liability at transition date for all outstanding leases, using present value of lease payments, discounted using the incremental borrowing rate on transition date.

Not yet discussed.

KPMG observation The key question not yet answered by the Boards is when the expected application date may be, and whether this will give entities sufficient time to rearrange current financing arrangements, if necessary.

4. FASB/IASB differencesAfter considering the responses to the DP, one area of difference between the IASB and FASB is a result of the tentative decisions regarding the lessee’s ability to revalue the right-of-use intangible asset. The IASB would permit revaluation if the IAS 38 criteria are met; however, revaluations are not permitted at all by US GAAP. In practice, as the IAS 38 criteria are unlikely to be met for such specific assets (i.e. no homogeneous products or active markets), a US GAAP difference to IFRS is expected to be rare.

Another difference relates to the IASB’s tentative decision that a lessor of investment properties would not be required to apply the new leases standard if it measures investment property at fair value in accordance with IAS 40. Measuring investment property at fair value is not permitted under US GAAP unless the reporting entity qualifies for fair value measurement of its investment assets in accordance with specialised industry accounting requirements; therefore the FASB plans to consider whether US GAAP should permit or require such fair value measurement for investment property for reporting entities that do not qualify for fair value measurement of their investment assets in accordance with specialised industry accounting requirements.

5. Lessor accounting example

The following example compares, from a lessor perspective, the current IAS 17 operating and finance lease models with the proposed performance obligation and derecognition approaches. Although included in the DP, the derecognition approach currently is not favoured by the Boards; it is illustrated here for the purposes of comparison.

This example features a simple lease and we have made a number of major simplifying assumptions. This has been done to illustrate the proposals, as, in our experience, leases in practice are likely to be significantly more complicated. However, even in this simple example, the accounting result for the lessor is significantly different in each case.

5.1 Fact patternOn 31 December 20x0 entity X owns a building which it has recognised as property, plant and equipment at 1,000, under the cost model, in its statement of financial position. On 1 January 20x1 X enters into a lease agreement with

lessee Y. The lease term is 10 years and Y has the option to extend the lease term for another 4 years. X estimates the likelihood of Y exercising the option to extend the lease term by another 4 years to be 60 percent; it is not considered to be reasonably certain. The annual lease payments are 100 plus 0.5 percent of Y’s revenue and are payable on 31 December each year. X estimates that the residual value of the building will be 356 after 10 years and will not be material after 14 years.

Assume that X is able to estimate reliably Y’s future revenue based on Y’s recent financial performance and an expectation about the development of economic circumstances. X estimates the likelihood of Y’s annual revenue in the next 14 years to be as shown in the table.

Assume for the purposes of illustration that the interest rate implicit in the lease is 4.84 percent and that this is equivalent to Y’s incremental borrowing rate. This simplifying assumption is unlikely to be the case in practice but aids in the comparison of the different models.

Y’s expected annual revenue

Less than 3,500 3,500 4,100 4,400

More than 4,400

Likelihood 5% 25% 45% 20% 5%


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5.2 IAS 17 operating lease modelUnder the existing guidance contained in IAS 17, X would continue to recognise the building as property plant and equipment in its statement of financial position. X would measure the building in accordance with applicable IFRSs throughout the lease term. Assuming straight-line depreciation over the leased asset’s useful life of 14 years, depreciation expense in 20x1 would be 71 (1,000 / 14).

X would recognise rentals as income in its statement of comprehensive income. Typically, X would recognise the minimum annual rental of 100 on a straight-line basis over the lease term and would recognise the contingent rent, i.e. the variable amount that depends on Y’s sales, in the periods in which it was earned. X would recognise an asset or liability in its statement of financial position to the extent that there is a timing difference between the periods in which the rentals are recognised as income and received in cash.

5.3 IAS 17 Finance lease modelUnder the existing guidance contained in IAS 17, X derecognises the building from its statement of financial position and recognises a lease receivable at the amount of its net investment, which comprises the present value of the minimum lease payments discounted at 4.84 percent, plus its interest in the unguaranteed residual value of the building at the end of the lease term.

Under IAS 17, minimum lease payments do not include contingent rent amounts and the lease term includes the non-cancellable period of the contract and any further periods for which the lessee has an option to continue to lease the asset that, at inception of the lease, is judged reasonably certain to be exercised. This means that in the example given, the minimum lease payments are

100 per year over the next 10 years. In this case, the lease receivable amounts to 1,000 at inception of the lease (the present value of the lease payments is 778 and the present value of the residual value is 222). Since the carrying amount of the lease receivable on initial recognition equals the carrying amount of the building, X recognises no day one gain or loss in its statement of comprehensive income.

During 20x1, X will recognise in its statement of comprehensive income finance income of 49 arising on the finance lease receivable. The carrying amount of the finance lease receivable will increase by the amount of the finance income and decrease by the rental payment of 100 so that at the end of 20x1 the lease receivable amounts to 949, i.e. 51 of “principal” has been repaid by the lessee. In addition, assuming that Y’s revenue in year one amounts to 4,000, X recognises contingent rents of 20 (4,000 * 0.5%) in income.

5.4 Performance obligation approachUnder the Board’s proposals, X would recognise in its statement of financial position a lease receivable that represents the right to receive payments from the lessee. Also, X would recognise a liability representing its ongoing obligation to make the building available to Y. At the same time, X would continue to recognise the building in its statement of financial position, measured in accordance with applicable IFRSs.

The amount that X recognises as a lease receivable takes into consideration the lease term and contingent rentals. The lease term would be the longest possible lease term that is more likely than not to occur. Since X expects the likelihood of Y exercising the option to extend the lease term for another 4 years to be 60 percent, which is more likely

than not, the lease term would be considered to be 14 years.

X would use an expected outcome technique to estimate the amount of contingent rentals over the next 14 years. Since it would not be necessary to consider every possible scenario, it is likely that the possibility of Y’s revenue exceeding 4,400 (5 percent chance) as well as not reaching CU3,500 (5 percent chance) can be ignored. As such, the expected outcome of Y’s annual revenue would be 4,000 [((3,500 * 25) + (4,100 * 45) + (4,400 * 20)) / 90]. Accordingly, the annual contingent rent would be 20 (4,000 * 0.5%). This means that for the purpose of measuring the receivable the annual lease payments would be considered to be 120.

Consequently, the lease receivable and corresponding performance obligation at inception of the lease, assuming that the residual value at the end of year 14 is nil, would be calculated as the present value of 14 annual payments of 120 using the interest rate implicit in the lease, of 4.84 percent, being 1,200. Note that this is significantly higher than the receivable of 1,000 recognised initially under the IAS 17 finance lease approach.

Assuming that Y’s revenue in year one is 4,000 and the rent received by X amounts to 120, the lease receivable at the end of 20x1 would amount to 1,138, which means that 62 has been repaid by the lessee and 58 is recognised as finance income. Also, X would recognise revenue from amortisation of its liability to make the building available to Y, most likely being 86 per year (1,200 / 14).

5.5 Derecognition approachUnder the derecognition approach, the lease contract is viewed as if it has transferred a portion of the leased item. The lessor derecognises the leased item, and recognises a lease receivable (see above) and a residual value asset,


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i.e. an asset that represents the lessor’s residual rights in the leased item at the end of the lease term. Under this approach, the lessor does not recognise a liability for its ongoing obligation to make the building available to Y. X would recognise a lease receivable of 1,200. As the carrying amount of the leased asset is 1,000, in this example there is a difference of 200.

To date the Boards have not discussed in detail the mechanics of the derecognition approach. One of the areas in which no tentative decisions have been taken is whether any upfront revenue (the difference of 200 mentioned above) would be recognised under the derecognition approach. If no upfront revenue is recognised, then it is considered that the lessor

has transferred to the lessee the right to use the leased asset, resulting in a transfer within the statement of financial position.

Summary of accounting consequences for lessors

IAS 17 – Operating lease

IAS 17 – Finance lease

Performance obligation approach

Derecognition approach

Assets at inception - Underlying leased asset - Lease receivable

1,0000

01,000

1,0001,200

01,200

Total assets 1,000 1,000 2,200 1,200

Liabilities at inception - Lease obligation 0 0 1,200 0

Total net assets 1,000 1,000 1,000 unclear

Profit and loss in year one - Rental income - Contingent rentals - Finance income - Depreciation expense - Gain (loss) at inception of lease

100200

(71)0

0204900

860

58(71)

0

00

580

unclear

Total net profit / (loss) 49 69 73 unclear

6. Next stepsThe IASB anticipates releasing an ED in June 2010, with a final standard expected in July 2011. Key milestones and outstanding issues are set out below.

6.1 Key dates

Timeline Topic for discussion

February / March 2010 Discussions on outstanding issues

April 2010 Meeting with Working Group to provide input on draft ED

June 2010 Publish ED

October 2010 Comments due on ED

November 2010 Meeting with Working Group to discuss ED

December 2010 – June 2011 Summary of comments and discussion on issues raised in the ED comment letters

June 2011 Pre-balloting and sweep

July 2011 Publication of final standard

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6.2 Potential topics to be discussed

TopicLessee /Lessor Question to be addressed

Contracts representing the purchase of the underlying item

Both What criteria should apply for exclusion of purchases (e.g. bargain purchase options)?

Option to purchase Both Should purchase options be accounted for as options to extend or terminate?

Lessor options Lessee How should lessor options be accounted for?

Contingent rentals Both Should changes in liability (e.g. changes as a result of changes in the estimation about contingent rentals) be recognised in profit and loss or the right-of-use asset?

Residual value guarantee

Lessor How should a lease that includes a residual value guarantee be accounted for by a lessor?

Interest in upside residual value

Lessee Should an interest in upside residual value be recognised as a separate asset or a reduction to liability?

Sale and lease back Both Are additional criteria needed to determine when a sale may be recognised? What accounting applies when sales prices or rental payments are not at market rates?

Separation of service arrangements

Lessee Should there be guidance on how to separate lease payments from service arrangement payments?

Sub-leases Lessee Should there be separate guidance / requirements for intermediate leases?

Presentation Both For lessees, should disclosure in the financial statements be based on the underlying leased asset or an intangible asset classification?How should lessor present the assets, liabilities, revenues and expenses in the financial statements?

Transition Lessor What transition relief should be granted?

The activities on this project may be monitored through the IASB website at http://www.iasb.org and the FASB website at http://www.fasb.org, where summaries of the Boards’ meetings, meeting materials, and project summaries and status are available.

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Publication name: IFRS – Leases Newsletter

Publication number: Issue 1

Publication date: February 2010

ifrs – leases newsletter - kpmg · ifrs – leases newsletter february 2010, ... models, notably...

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