Project Update

Leases—Joint Project of the IASB and FASB

Last Updated: April 30, 2008 (Updated sections are indicated with an asterisk *)

This project update summarizes the project activities and decisions of the IASB and the FASB (Boards). It was prepared by the staff and is for the information and convenience of their constituents. All decisions of the Boards are tentative, may change at future Board meetings, and do not change current accounting and reporting requirements. Decisions of the Boards become final only after extensive due process.

Project Objectives
Project Plan
Decisions Reached at the Last Meeting
Summary of Decisions Reached to Date
*Next Steps
Board/Other Public Meeting Dates
*Background Information
Contact Information

Project Objectives

The objective of the accounting for leases project is to comprehensively reconsider the guidance in FASB Statement No. 13, Accounting for Leases, and IAS 17, Leases, along with subsequent amendments and interpretations, to ensure that financial statements provide useful, transparent, and complete information about leasing transactions to investors and other users of financial statements.

Project Plan

The International Accounting Standards Board (IASB) and the FASB are carrying out this project with the help of a joint international working group that will consult on lease accounting issues. Working group members will provide expert advice on staff and Board proposals and implementation issues while offering practical considerations from a variety of perspectives (lessor, lessee, users of financial statements, and auditors). The working group will provide input through a mixture of formal meetings, conference calls, and email.

Decisions Reached at the Last Meeting

See minutes below.

Summary of Decisions Reached to Date

Scope

The project will initially focus on the accounting for lease arrangements within the scope of existing lease accounting literature. Prior to publishing a Preliminary Views document, the Boards will consider whether to extend the scope of the project to other arrangements that convey a right to use another entity’s asset (see April 2007 minutes).

Analysis of Rights and Obligations in a Simple Lease Contract

A lessee has an asset for the right to use the leased item over the lease term and a liability for the obligation to make payments over the lease term. The lessee's obligation to return the leased item does not meet the definition of a liability; however, asset retirement obligations or requirements to return the equipment in a specified condition may constitute liabilities.

A lessor has an asset for the right to receive payments over the lease term.

Analysis of whether the rights and obligations arising in a lease contract meet the definition of an asset or a liability should be based on the definitions in the existing conceptual framework; however, the staff should monitor proposed revisions to that framework in the ongoing conceptual framework project and consider whether those revisions would change the staff's analyses (see March 2007 minutes).

In addition to the above decisions reached by the Boards, below is a summary of Board discussions on the leases project; however, the Boards have not yet sought official consensus on these topics:

Analysis of Possible Accounting Models

The staff will continue to develop the right-of-use model; however, future decisions on measurement, presentation, derecognition, recognition, and scope could affect preliminary conclusions. In the right-of-use model, the lessee recognizes an asset for its right to use the leased item and a liability for its obligation to pay for that item. The lessor recognizes an asset for its right to receive payments from the lessee and its residual interest in the leased item at the end of the lease term; the lessor does not have a liability for its obligation to permit the lessee to use the leased item (see March 2007 minutes).

Measurement of a Lessee’s Liability to the Lessor, Measurement of a Lessee’s Right-of-Use Asset, and Initial Recognition of Assets and Liabilities in Lease Contracts

The Boards discussed alternative approaches to the initial and subsequent measurement of a lessee’s obligation to make payments to the lessor under a simple lease contract. They generally agreed that the lessee’s obligation to make payments to the lessor is a financial liability and, therefore, directed the staff to further explore the following approaches:

1. The lessee would initially measure its obligation to pay for the right-of-use asset at fair value.

2. The lessee would subsequently measure that liability using the effective interest method; however, the lessee also would have an option to subsequently measure the liability at fair value.

The Boards considered the following three alternative approaches for the initial and subsequent measurement of a lessee’s right-of-use asset arising under a simple lease contract: (1) the intangible asset approach, (2) the nature of the leased item approach, and (3) the separate accounting model approach. The IASB expressed a preference alternative (2), which uses the same technique for initial and subsequent measurement of the right-of-use asset arising in a lease of property, plant, and equipment as used in IAS 16, Property, Plant and Equipment. The IASB noted that under this approach, it would still be possible to present leased assets separately from owned assets. The FASB generally agreed with alternative (3) while noting that a lessee’s right-of-use asset is neither an intangible asset nor an asset that is similar in nature to the leased item. For that reason, the Boards generally agreed that existing guidance for the initial measurement of an intangible or tangible asset may not be the most relevant measure of a lessee’s right-of-use asset. The FASB directed the staff to develop an approach for the initial and subsequent measurement of a lessee’s right-of-use asset for consideration at a future meeting.

The Boards also discussed whether assets and liabilities arising in a lease contract should be recognized upon signing of the lease contract or upon access to or delivery of the leased item, but they did not reach any tentative conclusions. The IASB instructed the staff to further analyze the rights and obligations arising in lease contracts between the contract signing and the acceptance of the leased item (see June 2007 minutes).

Other Lessee Obligations

The Boards discussed lease arrangements that give rise to additional obligations of the lessee, including lessee obligations to incur costs to return the leased item, return the leased item in a specified condition, and maintain the leased item. The Boards considered whether those obligations meet the definition of a liability and, if so, when the liability arises. The Boards generally agreed that obligations to incur costs to return the leased item are liabilities that exist at the commencement of the lease term. The Boards also considered how to treat the debit arising on the recognition of the liability, how to measure the liability, and whether the obligations give rise to assets for the lessor (see October 2007 minutes).

Variable Lease Payments

The Boards discussed lease payments with a variable factor based on price changes or an index (such as the consumer price index), the lessee’s financial or operating performance from the leased item (such as profit-based rentals), and the lessee’s use of the leased item (such as excess mileage costs in car leases). The Boards considered whether these variable lease payments meet the definition of a liability and, if so, when the liability arises and how it should be measured. The Boards generally agreed that for rentals with a variable factor based on price changes or an index, the lessee has a liability for both the fixed and variable components (see October 2007 minutes).

Options to Extend or Terminate a Lease

The Boards discussed lease contracts that give the lessee an option to extend the lease for an additional period or an option to terminate the lease early, while considering some of the factors that affect whether a lessee will exercise an option to extend or terminate a lease. The Boards discussed whether the rights and obligations that arise under a simple lease with an option to extend the lease term meet the definitions of assets and liabilities under the conceptual framework.

The Boards discussed the following four approaches to accounting for options to extend or terminate a lease but did not reach any decision (See May 2007 minutes):

Approach 1—The lessee obtains the right–of-use asset for the period up to the option exercise date and an option to extend the lease.

Approach 2—The lessee obtains the right–of-use asset for the period of the lease including any possible extensions and an option to terminate the lease

Approach 3—The lessee obtains the right-of-use asset either for the period of the lease including any possible extensions or for the period up to the option exercise date. The assets and liabilities recognized are based on the most probable lease term after considering all of the substantive terms of the lease and the nature of the leased item. Under this approach, options are not separately recognized.

Approach 4—The lessee obtains a right-of-use asset in which measurement is based on the expected value of the payments under the lease. Under this approach, options are not separately recognized.

*Next Steps

At the April 2008 joint meeting in London, the Boards discussed updating the 2006 Memorandum of Understanding (MoU) (see Background information below), which includes the leases project. The Boards accepted the broad principles outlined in the joint meeting discussion paper and directed the staff to develop details for consideration in the Technical Plan update session at the Boards’ meetings in June 2008. It is the intention that an updated Work Plan will be published after the June 2008 Board meeting(s).

Board/Other Public Meeting Dates

The IASB meeting summaries and FASB meeting minutes are provided for the information and convenience of constituents who want to follow the Boards’ deliberations. All of the conclusions reported are tentative and may be changed at future Board meetings. Decisions become final only after a formal written ballot to issue a final Statement, Interpretation, FSP, or Statement 133 Implementation Issue.

Other Public Meetings

Joint International Working Group

The first joint working group meeting was held on February 15, 2007, in London. A copy of the full meeting agenda, agenda papers, and the audio webcast of the meeting can be found on the IASB website for the first meeting of the Joint Working Group on Lease Accounting. View the summary report of the February 2007 joint working group meeting.

*Background Information

Memorandum of Understanding (MoU)

In February 2006, the IASB and the FASB issued an MoU that described a joint work plan to expedite global convergence in accounting standards and that established a series of milestones to be reached by 2008. The leases project is part of the 2006 MoU. Under the 2006 MoU, the IASB and the FASB would have to consider and make a decision about the scope and timing of a potential leasing project by 2008. This goal was achieved when the IASB and the FASB added the leasing project to their respective agendas on July 19, 2006.

The Boards discussed updating the 2006 MoU at the April 2008 joint meeting.

History of the Leases Project

Statement 13, issued in 1976, provides guidance on accounting for leases for both lessors and lessees. According to the provisions of Statement 13, a lessee should recognize both an asset and a liability for a lease that transfers substantially all benefits and risks incident to the ownership of property, and a lessor should recognize such a lease as a sale or financing. Under Statement 13, a lease that does not transfer substantially all benefits and risks incident to the ownership of property is classified as an operating lease by the lessee. Under operating lease classification, the lessee does not recognize any elements of the lease on its balance sheet (that is, it does not recognize an asset for the right to use the leased item or a related liability for the future lease payments); rather, the lessee recognizes rental expense as it becomes payable.

IAS 17 was issued by the IASC in 1982 and was very similar to Statement 13 as it was based on the extent to which risks and rewards incident to ownership of a leased asset lie with the lessor or the lessee. Although IAS 17 has been amended several times, its most recent version retains the fundamental approach to the accounting for leases contained in the original standard.

Following the issuance of Statement 13 and IAS 17, the FASB, IASB, Emerging Issues Task Force (EITF), Standing Interpretations Committee (SIC), International Financial Reporting Interpretations Committee (IFRIC), Securities and Exchange Commission (SEC), and American Institute of Certified Public Accounting (AICPA) issued numerous pieces of guidance addressing various issues relating to the application of Statement 13 and IAS 17. Some believe that the additional guidance adds to the complexity of existing guidance in this area.

The Boards considered adding a lease accounting project to their agendas in response to the criticisms of many of their constituents, including the FASB’s Financial Accounting Standards Advisory Council (FASAC), the FASB’s User’s Advisory Council (UAC), and the SEC’s 2005 Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 On Arrangements with Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Issuers (Off-Balance Sheet Report). Many of those constituents indicated that current lease accounting standards fail to provide complete, transparent information and urged the Boards to undertake a lease accounting project. Also, in June 2004, the IASB and the FASB agreed that accounting for leases was in need of a fresh look and that any resulting improvements should be made through a major project conducted jointly when resources permitted.

Standard-setting activity during the past 20 years has not been limited to merely interpreting the leasing approach in Statement 13 and IAS 17. For example, a group of international standards setters (including FASB representatives), referred to as “the G4+1,” undertook an effort to reconsider the accounting for leases based on the existing conceptual framework. Their efforts resulted in the issuance of two Special Reports issued in 1996 and 1999, respectively: Accounting for Leases: A New Approach and Leases: Implementation of a New Approach. These reports describe a proposed conceptual approach to lease accounting focusing on the fundamental components of lease transactions.

The issues relating to lease accounting that need to be addressed are much the same as those previously considered in the G4+1 Special Reports. However, the objective is to analyze these issues in terms that are consistent with current projects, particularly those on revenue recognition, nonfinancial liabilities, derecognition, and the conceptual framework.In July 2006, the FASB and the IASB decided to add a joint leasing project to their respective agendas because of their concern that the current accounting in this area does not clearly portray the resources and obligations arising from lease transactions.

Working Group

During the third quarter of 2006, the Boards sent out an invitation for nominations to join the joint international working group planned for this project (invitation for nominations). In the fourth quarter of 2006, the Boards announced the members of the working group (announcement of working group members).

Contact Information

FASB Contacts:

Danielle Zeyher
Project Manager
dtzeyher@fasb.org

Jeff Nickell
Practice Fellow
jtnickell@fasb.org

IASB Contacts:

Rachel Knubley
Project Manager
rknubley@iasb.org

Simon Peerless
Project Manager
speerless@iasb.org

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