FYI Article – Leases: IASB Makes Proposals More Cost Effective
In January 2014, the International Accounting Standards Board (IASB) started to consider the feedback received on its May 2013 revised Exposure Draft on leases. The IASB received extensive feedback, including that of numerous preparers who concluded that the accounting proposed in the Exposure Draft would be very complex and costly to apply.
In response, the IASB made some tentative changes to the proposals. It is increasingly apparent that cost/benefit considerations were pivotal to several of these decisions.
The objective of the Leases project is to record all significant leases, including operating leases, on the balance sheet, similar to current requirements for capital leases. A joint project with the U.S. Financial Accounting Standards Board, the two boards reached different conclusions on some of the issues. This article focuses on the IASB’s decisions only.
The Original Proposals
The Exposure Draft proposed a dual approach to the recognition, measurement and presentation of expenses and cash flows arising from a lease:
- For some types of leases (labelled Type A leases), a lessee would report amortization of the asset separately from interest on the lease liability, similar to capital leases today.
- For other types of leases (labelled Type B leases), a lessee would report a straight-line lease expense in its income statement.
Many respondents to the Exposure Draft thought that a dual approach was operationally complex to implement because it requires determining, for each lease, what type it is, and the accounting processes differ for each type.
What’s Happening Now?
Lessee accounting model
The IASB decided on a single approach for lessee accounting where all leases are accounted for the same way (i.e., as Type A leases), eliminating the distinction between the two types that was included in the Exposure Draft.
Lessor accounting model
The IASB also decided that no significant changes are needed to the current lessor accounting model in IFRSs and eliminated the proposed receivable and residual approach. Therefore, a lessor will classify and account for its leases using guidance similar to the current requirements in IAS 17 Leases.
Small-ticket and short-term leases
Many constituents were concerned that, since lessees often have numerous leases that are high in volume, small in value and not material to users, the cost of applying the proposals to those leases would exceed the benefits. The IASB decided to provide cost relief by permitting lessees, as an accounting policy choice, to not capitalize leases of small assets. Additionally, the proposed recognition and measurement exemption for short-term leases of 12 months or less will be retained. However, the definition of a short-term lease will be revised and this will increase the number of leases that qualify for the exemption.
The IASB also decided to address the cost concerns of implementing the proposals for entities with a large number of leases that have similar characteristics (for example, leases of a fleet of similar cars). Both lessees and lessors will be permitted to account for leases at a portfolio level (rather than a lease-by-lease basis) when doing so would not result in a material difference from accounting for the leases on an individual basis.
Reassessment and remeasurement
Many respondents disagreed with the Exposure Draft proposals on when reassessment of the lease term and remeasurement of the right-of-use asset and lease liability would be required. The concern is that there would be significant costs and complexities in performing individual reassessments of each lease, particularly for companies with a large number of leases.
In response, the IASB will limit the circumstances in which reassessment would be required, as compared to the proposals in the Exposure Draft. A lessee is required to reassess the lease term only upon the occurrence of a significant event or a significant change in circumstances that is within the lessee’s control. A lessee is only required to reassess variable lease payments that depend on an index or a rate when there is a contractual change in the cash flows. A lessor is not required to reassess the lease term or reassess variable lease payments that depend on an index or a rate.
Separating lease and non-lease components
Some constituents disagreed with the proposal requiring lessees to separate lease and non-lease components. They argued that it would be costly to do so, with little added benefit to users, particularly for lessees with a large number of contracts.
The IASB, as a practical expedient, decided to allow lessees an accounting policy choice by class of asset to not separate lease components from non-lease components and instead account for the components together as a single lease component. Lessees will also be allowed to use estimation techniques (for example, a residual approach) in determining the stand-alone selling prices of components if observable prices are not available.
The IASB will continue its redeliberations on this project at future meetings.
Grace Lang, CPA, CA, CPA (Illinois)
Principal, Accounting Standards Board
Phone: +1 (416) 204-3478