IFRS – Leases Newsletter - KPMGIFRS – Leases Newsletter May 2010, Issue 2 This edition of IFRS – Leases Newsletter highlights key developments relating to the joint International

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IFRS – Leases NewsletterMay 2010, Issue 2

This edition of 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 on the proposed lessor accounting model.

Contents

1. Projectoverview 12. Recentdevelopments 23. Currentstatus 44. FASB/IASBdifferences 145. Nextsteps 14

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. A key component of the Boards’ proposals has been the intention 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.

For lessees, this remains the Boards’ intention. The Boards propose that lessees adopt 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 make future lease payments. That is, all leases will be “on-balance sheet” for lessees, subject to certain scope exemptions.

For lessors, the situation is becoming more complex. In their May meeting, the Boards debated aspects of two lessor accounting models: the performance obligation model and the derecognition model. The FASB supports the application of the first of these models to all leases; the IASB believes that the nature of lease should determine which model a lessor applies. The continuing debates about lessor accounting will place pressure on the Boards’ current plan to publish an exposure draft of a new Leases standard in June 2010.


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2. Recent developmentsThe IASB and FASB continue to develop proposals for lessee and lessor accounting, with the intention of a joint exposure draft to be issued before the end of June 2010. Some of the recent key decisions, since the last newsletter, discussed in more detail in the current status section, are

as follows.

2.1 The lessor accounting modelOne of our key concerns about the Boards’ joint discussion paper (DP) on leases, published in March 2009, was that it focused on lessee accounting. We and other commentators urged the Boards to develop their thinking on lessor accounting and lessee accounting in parallel. The Boards have recently devoted significant time to lessor accounting issues and have now decided to expose two significantly different lessor accounting models for comment: the performance obligation model and the derecognition model.

TheperformanceobligationmodelThe performance obligation model focuses on the additional rights and obligations created by the lease contract. Under this model, the lessor continues to recognise its interest in the underlying leased asset and recognises a new asset for its right to receive future lease payments (or lease receivable) and a corresponding liability for its obligation to deliver use of the leased asset to the lessee (or performance obligation liability).

During the lease term, the lessor will continue to recognise depreciation on the leased asset, and recognises finance income on amounts receivable from the lessee and income arising from amortisation of the performance obligation.

The lessor is unlikely to recognise a gain on commencement of a lease under this model, assuming that the lessor has a single performance obligation, being its obligation to grant the lessee the right to use the asset for the lease term.

ThederecognitionmodelThe derecognition model views the lease contract as if it has transferred a portion of the leased asset to the lessee. Under this model, a lessor derecognises a portion of the leased asset, continues to recognise the remaining portion of the leased asset (the residual value asset) and recognises a lease receivable due from the lessee.

During the lease term, the lessor will recognise finance income on amounts receivable from the lessee and any impairment of its residual interest in the leased asset.

The lessor may recognise a gain on commencement of the lease under this model, if the initial carrying amount of the lease receivable exceeds the carrying amount of the portion of the leased asset that is derecognised.

ChoosingbetweenthemodelsThe two models reflect different views of the nature of the lease contract. The first edition of this newsletter included a worked example illustrating the two models.

In its May 2010 meeting, the FASB supported the performance obligation approach, arguing that it should be applied to all lease contracts (subject to specific scope exemptions). The IASB noted that leases have different characteristics and that different lessors may have different business models; the IASB therefore favours exposing both models for comment and proposes to develop criteria to determine when each should be applied.

Those concerned with convergence between International Financial Reporting Standards (IFRS) and US GAAP may be disappointed with these decisions; those who believed that the Boards were committed to introducing a single lease accounting model may be surprised.

2.2 Scope We believe that any new standard on lease accounting should include robust guidance on scope. If the right-of-use approach is adopted whilst the generality of executory contracts remain “off-balance sheet”, then the scope of the proposed standard will become a key focus area for structuring opportunities.

The Boards have now agreed to revise the definition of a lease to incorporate

Comparison of lessor accounting models

Performance obligation model Derecognition model

Statement of financial position Underlying leased assetReceivable for future lease paymentsLiability to deliver use of asset

Residual value assetReceivable for future lease payments

Statement of comprehensive income

Asset depreciationFinance incomeAmortisation of liabilityNo day one gain

Asset depreciationFinance incomePossible day one gain


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and clarify the guidance in IFRIC 4 Determining whether an Arrangement contains a Lease. Until this guidance is provided it is difficult to predict whether the scope of the proposals will be broader or narrower than the current IAS 17 Leases scope.

In addition, further guidance is to be provided on how to distinguish between service and lease elements. As service elements are executory contracts, unlike the lease elements, they will not give rise to assets and liabilities recognised at inception. Distinct services are to be separated, generally identified when others are offering the same service, the contract specifically refers to the service, there is a distinct function or profit margin, or the service is clearly delivered at a distinct time. The incentive to appropriately allocate payments is that, if not allocated, then the entire arrangement is considered a lease, regardless of the materiality of the service element.

In-substance purchases (lessee) and sales (lessor) will be exempted from the proposals. An in-substance purchase/sale is one in which control passes to the lessee at the end of the contract, and the risks and rewards retained by the lessor are not more than trivial. The criteria for control passing are similar to the existing finance lease requirements with the exception that the present value of the minimum lease payments representing substantially all of the fair value is not

considered an indicator. Accordingly, many existing finance leases will become in-substance purchases outside the scope of the proposals, with the contractual payments falling within the scope of IAS 39 Financial Instruments: Recognition and Measurement or IFRS 9 Financial Instruments.

2.3 Leases of landMany lessees and lessors are currently revisiting their current accounting for long leases of land, in light of the amendments to IAS 17 removing the “rule” that a lease of land that does not transfer title normally is an operating lease. The Boards have decided that very long leases of land will not be considered in-substance purchases/sales outside the scope of the proposals and will not be the subject of a specific exemption.

A lessee will recognise a right-of-use asset and a liability for its obligation to make future lease payments, as for other leases. Lessees who currently classify leases of land as operating leases will therefore bring such leases on-balance sheet under these proposals. A lessee who has classified a lease of land as a finance lease under the IAS 17 amendments may need to reassess the carrying amount of its recognised asset and liability.

A lessor following the performance obligation model will continue to recognise the land as an asset, and will recognise additionally a lease

receivable and a performance obligation liability. A lessor following the derecognition model will derecognise a portion of the land, possibly recording a day one gain.

Definition and scope

Definition Within scope Outside scope

A contract in which the right to use a specified asset is conveyed for a period of time in exchange for consideration

¬¬ Leases of non-core assets¬¬ Long leases of land¬¬ Short-term leases (simplified

model)

¬¬ Leases of biological assets¬¬ Leases of intangible assets (other

than right-of-use assets)¬¬ Leases of natural resources¬¬ In-substance purchases/sales¬¬ Investment properties measured

at fair value through profit or loss (lessor only)


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3. Current statusThe status of the leases project at 20 May 2010 and key decisions made to date are outlined in the table below. The table explains the performance obligation model, which the Boards previously favoured and have developed more fully. As discussed in section 2 above, the IASB now wishes to expose this model and the alternative derecognition model.

Topics on which there have been significant developments since the first edition of this IFRS Leases Newsletter are marked with “#”.

Topic Tentative decision – lessee right-of-use model

Tentative decision – lessor performance obligation model

Scope – identification of leases#

A lease is a contract which conveys the right to use an asset for a period of time, in exchange for consideration. In order to meet this definition, the contract must relate to a specified asset and convey the right to control use of that asset.

If a distinct service component exists within a contract that contains a lease, then the total payments should be allocated between the service and lease components according to their relative fair values.

If the total payments cannot be allocated between the service and lease components, then the entire arrangement is treated as a lease. All contracts that are negotiated concurrently with a third party must be considered together.

Changes in payments after inception should consider whether the change is directly attributable to either the service or the lease element, and if not, then allocated on a pro-rata basis.

KPMG observation The definition of a lease is not limited to contracts in which the underlying leased asset is property, plant and equipment, though a number of scope exemptions are proposed (see below).

We welcome the Boards’ efforts to reconsider the definition of a lease and clarify the distinction between service (executory) contracts and those conveying the right to use an asset. It is vital that the definition is robust and operational, as it is likely to come under considerable scrutiny for as long as there are different accounting requirements for lease and service contracts. It will also be important that the proposals for identifying and measuring distinct lease and service components are consistent with those for identifying and measuring distinct performance obligations under the revenue project.

The proposals to identify when services are distinct, and to consider all arrangements concurrently negotiated together, attempt to ensure the service and lease components are considered at market value, regardless of whether the contract specifies higher than market rates for the service component. Whilst it may be difficult and arbitrary to allocate payments between the service and lease components, the penalty for not doing so is to treat the entire arrangement as a lease, regardless of the materiality of the service element.

The definition of a lease incorporates the principles of IFRIC 4. Existing guidance in IFRIC 4 will be carried forward, but rewritten to provide further clarification. Until this guidance is available it is difficult to assess whether the scope of the proposals will be wider than the current requirements.


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Scope – exclusions Leases involving the following would be excluded from the proposals:

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

¬¬ In-substance purchases (i.e. contracts in which control of the underlying asset and all but a trivial amount of the risks and benefits are transferred to the lessee at the end of the contract) are not in the scope of the proposals.

Very long leases of land will not be considered in-substance purchases and will not receive a specific exemption from the proposals.

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 decisions to exclude leases of intangible assets and leases of biological assets appear 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 transactions. The distinction will be more important for lessors than lessees, as the outcome under lessor accounting is substantially different to sale accounting.

Very long leases of land will not be considered in-substance purchases or given an exemption from the proposals. Accordingly the lessee will recognise a right-of-use asset and a liability for its obligation to pay, as discussed below. Those entities that have recently reclassified long leases of land as finance leases under the amendments to IAS 17 may recognise different amounts under these new proposals.

Scope – investment property leases

Investment property leases would be in the scope of the proposals.

For entities reporting under IFRS, the proposals 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 proposals. 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 lessors in the real estate community who feel that the proposed lease accounting model does 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 Under the right-of-use model, the lessee recognises:

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

¬¬ a liability for the obligation to make future lease payments; and

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

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

Under the performance obligation model, the lessor recognises:

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

future lease payments;¬¬ a liability representing the obligation to

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

depreciation of the leased asset.

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

KPMG observation The lessee proposals require a separate (gross) presentation of the right-of-use asset and the liability for the obligation to make future lease payments. 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 and with the proposed lessor disclosure (see below).

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.

The gross value of the lease assets and liabilities would be recognised at commencement of the lease term (the date of delivery of the underlying asset), measured at the inception of the lease (the date of contract execution).

KPMG observation Net recognition of the contract asset and liabilities prior to delivery of the leased asset is consistent with other forward contracts and also is consistent with the current revenue recognition project decisions. However, it is not yet clear whether the net contract position would be remeasured prior to commencement. The tentative decision under the revenue recognition project is that a contract asset or liability is measured initially at cost and is remeasured subsequently only if the contract becomes onerous.


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Initial measurement – liability

At the present value of the lease payments, discounted using the:

¬¬ lessee’s incremental borrowing rate (preferred); or

¬¬ interest rate charged by the lessor if readily determinable (permitted).

At the transaction price, being the present value of the lease payments, discounted using the rate the lessor is charging the lessee.

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 Although the liability for the obligation to make future lease payments 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 liability to be discounted at the rate charged by the lessor 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 the performance obligation model is that there no longer would be upfront revenue recognition for manufacturer or dealer lessors that enter into leases (though revenue will arise on in-substance sales scoped out of the proposals).

Initial measurement – asset

Cost, represented by:

¬¬ the present value of the lease payments (effectively the liability amount, assuming there are no prepaid amounts); and

¬¬ initial direct costs.

Cost, represented by:

¬¬ the present value of the lease payments discounted using rate the lessor is charging the lessee; and

¬¬ initial direct costs.

The 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.

Initial direct costs are incremental costs directly attributable to negotiating and arranging a lease. Guidance will indicate general overheads, advertising, soliciting potential leases, servicing existing leases and other ancillary activity costs are not direct costs.


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KPMG observation The capitalisation of initial direct costs, and the possibility that a lessee and lessor will use a different discount rate, mean that the initial carrying amounts of the balances recognised by the lessee and lessor may be different, even if they make the same assumptions about lease term, contingent rentals etc.

The capitalisation of initial indirect costs would not be consistent with the requirements for transaction costs in IFRS 3 Business Combinations (2008), but is consistent with costs of acquiring property, plant and equipment and intangible assets.

Although the right to receive future lease payments 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.

The Boards may provide further guidance on determining the discount rate for a lessor. The Boards consider that, in theory, the interest rate the lessor is charging the lessee should result in lease payments being discounted to the fair value of the right-of-use asset.

The Boards will consider further when and how revenue should be recognised by a lessor upon lease commencement. However, upfront recognition of revenue would appear incompatible with the performance obligation model as described to date.

Subsequent measurement – liability

For subsequent measurement of the liability to make future lease payments:

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

¬¬ do not reassess for a change in the incremental borrowing rate; and

¬¬ do not permit measurement of the liability at fair value.

For subsequent measurement of the liability for the obligation to deliver use of the leased asset:

¬¬ recognise decreases as ’lease income’; and¬¬ amortise based on the pattern of use of the

underlying asset of the lessee (e.g. time, hours of use).

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 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 measured at fair value subsequently.

The amortisation proposals appear to focus on how the lessee uses the underlying asset, rather than on how the lessor satisfies its performance obligation to the lessee.

The Boards have not yet determined how revenue associated with options to purchase should be recognised and is considering whether this should be deferred until the option is exercised.


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Subsequent measurement – asset#

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 right-of-use asset to existing impairment testing requirements for non-financial assets; and

¬¬ permit revaluation even if there is no active market.

For subsequent measurement of the right to receive rental payments:

¬¬ measure at amortised cost using the effective interest method;

¬¬ do not reassess the discount rate for changes in lease payments; and

¬¬ conduct impairment test by first assessing the lease receivable, considering the impact of any impairment of the lease receivable on the obligation to deliver use of the leased asset (which may also be reduced/removed) and then assess the impact on the remaining underlying asset.

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 The Boards have reconsidered the circumstances in which a right-of-use asset may be revalued. Previously the IASB proposed to permit revaluation only when the conditions in IAS 38 for an active market were met, meaning that revaluations would have been rare.

The proposal to measure the asset at amortised cost using the effective interest method broadly is consistent with one of 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.

The apparent complexity of the impairment approach reflects the recognition by the lessor of three related balances for each lease under the performance obligation approach: the leased asset, the lease receivable and the performance obligation liability.

Options to extend or terminate the lease, or to purchase the underlying asset

For options to extend or terminate the lease, or to purchase the underlying asset:

¬¬ determine the 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 the date of renewal and lessee specific factors (i.e. past practice and intention);

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

¬¬ adjust changes from reassessment against the right-of-use asset (lessee) or performance obligation liability (lessor).

The discount rate is not adjusted for subsequent changes in the expected lease term.

Options to purchase the underlying asset should be treated consistently with options to extend or terminate the lease.


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KPMG observation We believe that determining the longest lease term that is more likely than not to occur 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 lease arrangements.

Contingent rentals For contingent rentals:

¬¬ recognise using an expected outcome technique (not using every possible scenario);¬¬ for lessors, the expected outcome technique includes only expected outcomes that can be

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

– readily available forward rates; or – spot rates at inception of the lease;

¬¬ reassess if new facts and circumstances indicate material changes in the liability; and¬¬ revise the discount rate only for changes when the rentals are contingent on variable reference

interest rates.

¬¬ recognise changes arising from current or prior periods (e.g. increases from current year sales) in profit or loss; and

¬¬ adjust other changes against the right-of-use asset (e.g. increases from estimates of future sales).

¬¬ allocate changes between the performance obligation liability and profit or loss, such that the portion of the change that relates to a satisfied performance obligation is recognised in profit or loss.

KPMG observation 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.

The approach taken to lessor contingent rentals is broadly consistent with the revenue recognition proposals related to changes in the estimates of variable consideration, which are allocated across performance obligations. However, the allocation may be difficult to determine in practice, for example if an additional rental payment is triggered only if a cumulative sales target is met over a number of periods.

Residual value guarantee

For residual value guarantees:

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

¬¬ reassess if new facts and circumstances indicate material changes in the liability;

¬¬ recognise changes arising from current or prior periods in profit or loss; and

¬¬ adjust other changes against the right-of-use asset.

For residual value guarantees:

¬¬ recognise amounts payable if they can be measured reliably, using an expected outcome technique (not using every possible scenario);

¬¬ reassess if new facts or circumstances indicate material changes in the receivable;

¬¬ recognise changes in the amounts payable against the receivable and the performance obligation liability; and

¬¬ account for residual value guarantees from unrelated third parties in the same manner as other guarantees (i.e. they are not accounted for as part of the lease accounting).


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KPMG observation The Boards consider that residual value guarantees are another form of contingent rental, and therefore the proposed requirements are consistent. It may be difficult for lessees to determine in practice whether a change in the expected outcome of a residual value guarantee relates to prior, current or future periods.

Sale and lease back

If the underlying asset has been sold (i.e. at the end of the contract control has been transferred and all but a trivial amount of risks and benefits have been transferred to the buyer/lessor), then:

¬¬ derecognise the underlying asset;¬¬ recognise a right-of-use asset;¬¬ recognise a liability for future lease

payments; and¬¬ recognise a gain/loss on sale.

If the underlying asset has been purchased (i.e. at the end of the contract control has been transferred and all but a trivial amount of risks and benefits have been transferred to the buyer/lessor), then:

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

leased asset; and¬¬ recognise a receivable for future lease

payments.

In sales and leasebacks not accounted for as financing transactions, if the sale or the leaseback is not established at fair value, the asset, liabilities, gains and losses are adjusted to reflect current market rentals.

KPMG observation The interaction and possible conflict between the sale-and-leaseback requirements, the exclusion of purchases from the lease proposals and the requirements of IAS 18 Revenue will be important. Under current IFRSs, the IFRS Interpretations Committee 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 lease proposals are based on a mix of control and risks/rewards and may result in different outcomes. The criteria for “sale” under a sale and leaseback are consistent with the criteria for “in-substance purchases” noted above. The indicators that the risks/rewards retained by the seller-lessee are more than trivial are based on the conditions precluding sale accounting in US GAAP for real estate sale-and-leasebacks. This may result in many (perhaps most) sale-and-leaseback transactions being accounted for as financings.

Sub-leases# An intermediate lessee/lessor entity should:

¬¬ as lessee in a head lease, recognise its right-of-use asset and a liability for its obligation to make future lease payments as discussed above;

¬¬ as lessor in a sub-lease, continue to recognise the right-of-use asset and a liability for its obligation to make future lease payments, recognise a receivable due from the ultimate lessee and recognise a liability for its obligation to provide the right-of-use asset; and

¬¬ present all assets and liabilities arising from sub-leases, excluding the liability for its obligation to make future lease payments under the head lease, gross in the statement of financial position, with a net subtotal.

KPMG observation It appears that these requirements may result in an economically identical head lease and sub-lease being measured differently. For example, when considering contingent rentals the lessor can only include contingent rentals in the measurement of the lease that are reliably measurable; however, the lessee only need to consider the expected outcome.


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Presentation and disclosure#

Present the lease liabilities separately from other financial liabilities on the face of the statement of financial position.

Present right-of-use assets with property, plant and equipment but separately from owned assets on the face of the statement of financial position.

Disclose amortisation and interest expense separately either on the face of the statement of comprehensive income or in the notes.

Classify cash lease payments (i.e. repayments of amounts borrowed and interest payments) as financing activities. Disclose quantitative and qualitative financial information identifying and explaining the amounts recorded including:

¬¬ a general description of lease activities, disaggregated by nature or function;

¬¬ whether the short-term lease exemption has been used;

¬¬ the material terms and conditions, gains and losses relating to sale and leasebacks;

¬¬ a reconciliation between opening and closing balances for right-of-use assets and liabilities to make future lease payments, including total cash paid;

¬¬ a narrative description of the assumptions and estimates on amortisation method, options, contingent rentals, residual value guarantees and discount rate;

¬¬ a maturity analysis of the gross liability to make future lease payments on an annual basis for the first five years, with a lump sum for the remainder, showing contractual maturities, reconciled to the liability recognised; and

¬¬ the nature and extent of the amount, timing and uncertainty of future cash flows and how these are managed.

Present the leased asset, lease receivable and performance obligation liability separately in the statement of financial position, totalling to a net lease asset or net lease liability.

Disclose interest income, lease income and depreciation expense separately in the statement of comprehensive income.

Disclose quantitative and qualitative financial information identifying and explaining the amounts recorded including:

¬¬ a general description of those lease arrangements;

¬¬ the existence and terms of renewal, termination and purchase options;

¬¬ a description of how the effect of contingent rentals on the carrying amounts of the lease receivable and performance obligation is determined;

¬¬ initial direct costs incurred;¬¬ a description of any restrictions placed

on leased assets and a description of the existence and terms of any residual value guarantees;

¬¬ for lease receivables, a maturity analysis on an annual basis for the first five years, with a lump sum for the remainder, comparing the potential differences in cash flows attributable to the minimum contractual receivables and the total estimated lease receivable;

¬¬ for performance obligations, disclosures required by the Revenue Recognition project;

¬¬ a reconciliation between opening and closing balances for the receivable and the performance obligation;

¬¬ information relating to risks surrounding a lease receivable in accordance with IFRS 7 Financial Instruments: Disclosure; and

¬¬ the fact that a lessor has applied a simplified form of lease accounting for short-term leases, if applicable, including the gross amount recognised in the statement of financial position in that respect.

KPMG observation The FASB has decided tentatively that lessor statement of comprehensive income disclosures should be totalled to a net lease income or net lease expense on the face of the statement.

The lessee cash flow recommendations mandate that lease interest be recognised as a financing activity. Currently, it may be recognised as operating or financing.


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Transition# Recognise the asset and liability at the transition date for all outstanding leases (except for simple finance leases), using the present value of lease payments, discounted using the lessee’s incremental borrowing rate on transition date. The right-of-use asset is measured on the same basis as the liability, except for impairment adjustments.

For simple finance leases that do not have options, contingent rentals or residual value guarantees, the measurement of the assets and liabilities is not changed. If the asset had been revalued under IAS 16, this becomes the carrying amount for the right-of-use intangible asset. Additional adjustments are made for prepaid or accrued rentals.

Recognise all outstanding leases at transition date using a simplified retrospective approach. Measure the receivable and liability at the present value of the remaining lease payments, discounted using the original rate charged by the lessor.

Previously derecognised leased assets are reinstated at depreciated cost, adjusted for impairment and revaluation.

Disclose transition impacts in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors, without adjusting basic and diluted earnings per share.

Both the lessee and lessor must separate any distinct service and lease components at transition date.

KPMG observation The proposed lessee transition requirements will assist transition for those with very simple leases. However, for other leases currently classified as finance leases, the transition requirements will require new calculations. In addition no transition relief has been proposed for the in-substance purchases now excluded from the proposals that may have been accounted for as finance leases under IAS 17, which therefore would have to apply fully retrospectively IAS 8.

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. We understand that the IASB plans to consult separately on the effective dates of a number of proposed new standards.

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4. FASB/IASB differencesAs discussed in sections 1 and 2, the IASB and FASB have different views on the accounting model for lessors. In other areas, the IASB and FASB generally have agreed on most aspects of lessee and lessor accounting, with some exceptions as described below.

The Boards have taken a different view on how to disclose the lessor’s income statement items. The IASB has decided tentatively that the lessor’s items in the statement of comprehensive income should be disclosed separately, without totalling to a net lease income or expense. The FASB has decided tentatively to require disclosure of net lease income or expense in the statement of comprehensive income.

After considering the responses to the DP, another 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 of the right-of-use asset even if there is no active market; however, revaluations are not permitted by US GAAP.

Another difference relates to the IASB’s tentative decision that a lessor of investment properties would not be required to apply the proposals if it measures investment property at fair value in accordance with IAS 40 Investment Property. 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. Next stepsThe Boards have devoted significant time to leases in recent joint meetings, with a view to publishing an exposure draft of a new standard in June 2010. If this target is met, then the anticipated timeline towards a new standard would be as follows:

Timeline Topic for discussion

June 2010 Publish exposure draft

October 2010 Comments due on exposure draft

November 2010 Meeting with Working Group to discuss exposure draft

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

June 2011 Pre-balloting and sweep

July 2011 Publication of final standard

However, the Boards’ most recent decisions on lessor accounting will place significant strain on the ability of the Boards to publish an exposure draft in June 2010. At the time of writing, the Boards have not yet commented on whether they will retain or revisit the timeline for this project.

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.


KPMG and the KPMG logo are registered trademarks of KPMG International Cooperative (“KPMG International”), a Swiss entity.

Publication name: IFRS – Leases Newsletter

Publication number: Issue 2

Publication date: May 2010

KPMG International Standards Group is a part of KPMG IFRG Limited.

KPMG International Cooperative (“KPMG International”), a Swiss entity that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever or vice versa.

This newsletter is based on KPMG’s observation of IASB, FASB, or joint meetings, summaries of the projects and meetings by the staff of the IASB and the FASB, and materials produced for these meetings. The broad models being considered by the Boards are subject to further changes as additional details are deliberated. The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity.

Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.

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http://www.iasb.org

http://www.fasb.org

http://www.fasb.org

Documents

IFRS – Leases Newsletter - KPMGIFRS – Leases Newsletter May 2010, Issue 2 This edition of IFRS – Leases Newsletter highlights key developments relating to the joint International