As most A&A followers know, this is one of the "big accounting changes" we have been hearing about for some time. I don’t want to bore you with a history of all of the twists and turns the journey to get here has taken; besides, only the nerdiest of A&A folks could keep from falling asleep at those details! To be fair, this is an ongoing debate. The final determinations for all stakeholders still need to be decided, but I wanted to provide a status update for those watching this issue closely. So here is summary of where things stand today.
During 2012, the boards concluded there are two different types of leases, for both lessors and lessees. The criteria used to distinguish between each type are the same and is as follows: whether the lessee acquires and consumes more than an insignificant portion of the underlying asset during the lease term is the determining factor. The difference in the models, however, is based on the amount of consumption displayed by a lessor or a lessee. Here are the main takeaway points:
Lessees would continue to recognize all leases on a balance sheet (other than short-term leases) by recording a right-to-use asset and a lease payment liability. However, the income statement impact over the life of the lease would be as follows:
- Property leases (for land or a building — or part of a building — or both) would be accounted for by using the straight-line approach unless the lease term lasts for the majority of the economic life of the underlying asset, or the present value of fixed lease payments accounts for (substantially) all of the fair value of the underlying asset.
- All other leases would be accounted for by using an accelerated approach unless the lease term is an insignificant portion of the economic life of the underlying asset, or the present value of the fixed lease payments is insignificant in relation to the fair value of the underlying asset.
In other words, for lessees, property leases are presumptively straight-line, while all other leases will presumptively reflect an accelerated pattern of expense recognition. The assumption can be overcome based on the amount of consumption.
Lessors would also report two types of leases. A receivable and residual approach would apply to leases for which the lessee acquires and consumes more than an insignificant portion of the underlying asset over the lease term. Otherwise, rental income would be recognized on a straight-line basis. To apply the receivable and residual approach:
- Lessors would derecognize the underlying asset; recognize a receivable for the right to receive lease payments and a residual asset for the asset that will be returned to the lessor at the end of the lease term.
- The receivable would be measured at the present value of the lease payments, while the residual asset would equal i) the present value of the estimated residual asset at the end of the term plus ii) deferred profit, which is the difference between the gross residual asset and the carrying amount of the underlying asset.
- Day one profit would equal the sum of the lease payment receivable and the residual asset, less the underlying asset that had been derecognized.
- Subsequently, the lease receivable would be accreted using the effective interest method, while the residual asset would be accreted to its estimated value at the end of the lease term. Profit would not be recognized until the underlying asset is subsequently sold or released.
Based on current expectations, real estate that is considered to be “investment property” would be excluded from the receivable and residual approach, in which case the straight-line method would apply. This would be similar to today’s operating-lease treatment.
The Boards plan to re-expose an updated draft of the leasing standard during the first part of 2013. For project details, please click on this link here
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