Dataline A look at current financial reporting issues - PwC

Dataline 

A look at current financial reporting 

issues 

No. 2012-11 

September 17, 2012 

What’s inside: 

Overview .......................... 1 

At a glance ............................... 1 

Overview of changes from 

existing GAAP ...................... 2 

Background of the project ...... 2 

The main details of the 

redeliberations ..................... 5 

Summary of 

the boards' 

redeliberations.............. 7 

Lessee expense recognition 

pattern .................................. 7 

Lessor accounting .................. 12 

Lease term .............................. 15 

Variable/uncertain cash 

flows .................................... 17 

Definition of a lease .............. 18 

Transition ............................. 20 

The path forward ..........23 

Questions .......................23 

Appendix: 

Other key areas ......... 24 

Leases — One size does not fit all 

A summary of the boards' redeliberations 

Overview 

At a glance 

The FASB and IASB jointly issued the initial leases exposure draft in August 2010 (the 

"initial ED"). A majority of the over 800 comment letters received raised significant 

concerns about the proposals. Redeliberations began in January 2011 and were 

substantially completed in July 2012. A "revised ED" is planned for the end of 

November 2012 (although this may slip into early 2013), with a 120-day comment 

period. Three FASB members and two of the IASB members stated they may present 

alternative views in the revised ED. 

The revised ED will retain the previously proposed "right of use" concept, and lessees 

would reflect all leases (except certain short term leases) on the balance sheet. Some 

lessors will derecognize the underlying leased asset, but others will continue to 

include it on the balance sheet. The revised ED will also propose a number of other 

changes to existing recognition, measurement, presentation, and disclosure guidance. 

The most significant changes to the initial ED will include: a dual model for lessees 

and lessors; a higher threshold for including extension options when measuring lease 

assets and liabilities; simplified treatment of many types of variable lease payments; 

and new guidance on applying the concepts of "specified asset" and "control" when 

determining whether a contract contains a lease. 

The revised ED will allow entities to apply a full retrospective approach or to elect 

certain reliefs to reduce the transition burden. Preparers will need to apply the 

guidance to all leases existing as of the beginning of the earliest comparative period 

presented (i.e., no grandfathering). 

Issuance of a final standard, although targeted for 2013, may slip into 2014. The 

effective date has yet to be discussed, but will likely not be before 2016. 

National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 1

Overview of changes from existing GAAP 

.1 The revised ED is expected to propose a number of changes from existing GAAP. The 

most significant changes are included in the following table: 

Overview of changes in a revised ED from existing GAAP 

Determination of whether an 

arrangement is or contains a lease 

Lessee accounting 

The analysis under existing GAAP to 

distinguish a service from a lease will be 

significantly changed as a result of clarification 

of what is a "specified asset" and alignment of 

"control" indicators closer to the guidance in 

the proposed revenue recognition standard and 

the latest consolidation guidance. 

All leases (except short term leases) will be 

recognized on the balance sheet. 

A dual model for income statement recognition 

will be retained; which model will apply would 

be based on whether the lessee "consumes" the 

underlying asset. 

Lessor accounting 

A dual model for balance sheet and income 

statement recognition will be retained; which 

model will apply would be based on the same 

principle of consumption as for lessee 

accounting. 

Current operating lease accounting will be 

retained for some leases; however, the finance 

lease approach will be replaced with the 

receivable and residual approach. 

Lease term, 

Variable/uncertain cash flows, and 

Reassessment 

The revised ED will alter the threshold for 

including in the measurement extension 

options and contingencies based on a 

rate/index. Reassessment will be required 

throughout the lease term. 

Background of the project 

.2 Leasing arrangements satisfy a wide variety of business needs, from short-term asset 

rentals to long-term asset financing. Leases allow lessees to use a wide range of assets, 

including office and retail space, equipment, trucks/cars, and aircraft, without having to 

make large initial cash outlays. Sometimes, leasing is the only option to obtain the use of 

a physical asset when it is not available for purchase (e.g., it is generally not possible to 

buy one floor of an office building). 

.3 Many observers have long believed that the current lease accounting model is not 

consistent with the FASB and IASB's conceptual frameworks, which provide the 

underpinnings for their accounting standards. They argue that the model allows lessees 

to structure lease transactions to result in operating lease classification and therefore 

receive off-balance sheet treatment. Critics also point out that the current standards 

permit something as seemingly illogical as a commercial airline not reporting any 

airplanes on its balance sheet. 


.4 In June 2005, the Securities and Exchange Commission (SEC) issued its 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 Users. One of the significant recommendations in this report 

was that existing lease standards needed to be rewritten, predominantly to eliminate offbalance 

sheet accounting by lessees. 

.5 As part of their global convergence process, the boards added a joint project on leases 

to their agendas in 2007 and have been working since to create a single, comparable, 

worldwide leasing standard. The project was intended to build on previous work 

contained in the 1999/2000 white paper titled G4+1 Special Report, Leases: 

Implementation of a New Approach. The initial ED published by the boards in August 

2010 was a follow up to a discussion paper published in March, 2009. 

PwC observation: 

While there are some differences, the core elements of existing U.S. GAAP and IFRS 

for leases are largely aligned today. Accordingly, while reaching a converged standard 

is a key consideration, the boards' joint leasing project is more about addressing 

perceived problems with the existing accounting model than aligning the guidance. 

Overview of the initial ED 

The definition of a lease under current GAAP is retained. 

Off-balance sheet accounting by lessees for operating leases is eliminated; 

essentially all assets currently leased would be brought on balance sheet. 

Rent expense is replaced by interest expense (which would be greater in earlier 

years, like a mortgage) plus straight-line amortization of the leased asset, such 

that total expense would be "frontloaded." Traditional financial performance 

ratios may no longer be useful; other operating metrics may evolve. 

Lease assets and liabilities would be recognized based on the present value of 

payments to be made over the term of the lease and subsequently measured at 

amortized cost. The payments would include “contingent” amounts, such as rents 

based on a percentage of a retailer’s sales and rent increases linked to changes in 

the Consumer Price Index. 

The lease term would include optional renewal periods that are "more likely than 

not" to be exercised (this is substantially different than today’s model). 

Lease renewal periods and variable lease payments would be continually 

reassessed, and the related estimates trued up as facts and circumstances change 

(again, substantially different than today's model which is largely "set-it and 

forget it"). 

A lessor would apply the "performance obligation" approach if it retains exposure 

to significant risks or benefits associated with the underlying asset during or after 

the expected lease term; the "de-recognition" approach would be used otherwise. 

This is known as the "dual model." 

Pre-existing leases would not be grandfathered. 

A "modified retrospective" approach for transition would be required (i.e., treat all 

leases in effect as if they started at the beginning of the earliest year presented). 


Annual Expense (in $) 

.6 For more information on the initial ED, refer to Dataline 2010-38, A new approach 

to lease accounting — Proposed rules would have far reaching implications (which 

provides an overview and various insights into the ED), Dataline 2011-05, Leasing — the 

responses are in . . . (which summarizes comment letters received), and 10Minutes on 

the future of lessee accounting (which provides insight into how companies will be 

impacted by the proposals in the ED and next steps to consider). 

.7 The boards' primary objective with the initial ED was to get all leases onto the 

balance sheet of lessees. However, the accounting proposed would significantly impact 

the income statement, and the changes to expense recognition and income statement 

presentation quickly became a significant area of focus. The graph below illustrates the 

differences in the expense recognition pattern between existing operating lease 

accounting, the proposed model in the initial ED, and cash rents for a basic ten-year 

lease with an initial annual rent of $2,000, a 2% annual escalation rate, and an assumed 

incremental borrowing rate of 7%. 

2,700 

2,600 

2,500 

2,400 

2,300 

2,200 

2,100 

2,000 

1,900 

1,800 

1,700 

1,600 

1,500 

1 2 3 4 5 6 7 8 9 10 

Years 

Initial ED Existing operating lease accounting Cash rents 

.8 Over 800 comment letters were received in response to the initial ED. A majority of 

the letters were supportive of the need for the project in general, especially with respect 

to the balance sheet issue for lessees. However, most respondents had significant 

concerns about many aspects of the proposals and strongly encouraged the boards to 

take the time necessary to produce a standard that is both high quality and operational. 

Common concerns centered on: 

Financial statement impact (especially the income/expense recognition patterns) 

Complexity/operationality 

Highly subjective estimates and judgments 

Time to implement 

Cost vs. benefit 


.9 In early 2011, the boards began redeliberations to address these concerns, the five 

key areas discussed in paragraph 13 below, and other issues. In discussions over the past 

18 months, the boards identified alternative approaches to reduce complexity and 

address certain application issues. They also conducted extensive outreach with users 

and preparers to understand the operationality and usefulness of their alternative 

approaches. 

.10 At their July 17, 2012 joint meeting, the boards substantially completed their 

redeliberations and instructed their staffs to begin drafting a revised ED. The boards plan 

to issue the revised ED by the end of November 2012 with a 120-day comment period. 

However, the issuance may slip into early 2013. 

.11 The difficulties encountered during the 18-month-long redeliberation process were 

highlighted when the board members were asked whether they planned to present an 

alternative view in the revised ED. Three of the seven FASB members and at least two of 

the IASB members stated they may present alternative views. However, the stated 

rationales for their alternative views are very different. The FASB members expressed 

significant concerns about whether some of the core objectives of the project are met in 

the revised ED. They question the overall cost/benefit proposition and whether the 

revised proposals will provide financial statement users with useful information. Other 

specific concerns include the accounting for variable lease payments, the effectiveness of 

the proposed disclosures, and the interaction of lessor accounting with the proposed 

revenue recognition model. 

.12 In contrast, IASB members contemplating presenting an alternative view primarily 

expressed concern about the conceptual merits of a dual, rather than single, lease 

accounting approach being applied by both lessees and lessors. 

The main details of the redeliberations 

.13 The boards have reached tentative decisions in each of the five key areas described in 

the table below. Many of their decisions significantly change the accounting in the initial 

ED. In addition, the boards reached tentative decisions on other key areas (refer to the 

appendix of this Dataline for further details). 

Topic Initial ED Revised ED 

Lessee 

expense 

recognition 

pattern 

A lessee should recognize 

amortization of the right-of-use 

asset (straight-line), and interest 

on the liability to make lease 

payments (effective interest rate). 

The result is a front loading of 

expense in the income statement. 

Some lessees will apply an 

expense recognition approach 

similar to that proposed in the 

initial ED; some will use an 

approach that results in 

straight-line lease expense. 

Which recognition approach to 

apply will depend on the level 

of consumption of the 

underlying asset. A practical 

expedient will apply based on 

the nature of the underlying 

asset (property versus nonproperty, 

such as equipment). 


Topic Initial ED Revised ED 

Lessor 

accounting 

Lease term 

Variable/ 

uncertain cash 

flows 

Definition of a 

lease 

A lessor should apply the 

performance obligation approach if 

the lessor retains significant risks 

or benefits of the underlying asset 

during or after the expected lease 

term; if not, apply the 

derecognition approach. This was 

known as the "dual model." 

A lessee or lessor should determine 

the lease term as the longest 

possible term that is more likely 

than not to occur taking into 

account the effect of any options to 

extend or terminate the lease. 

Contingent rentals and expected 

payments under term option 

penalties and residual value 

guarantees should be included in 

the measurement of assets and 

liabilities arising from a lease using 

an expected outcome technique. 

Definition substantially carried 

forward from IAS 17/ASC 840 and 

defined as "a contract in which the 

right to use a specified asset is 

conveyed, for a period of time, in 

exchange for consideration." 

A lessor distinguishes between 

leases to which the "receivable 

and residual" approach 

(similar to the derecognition 

approach) applies and leases to 

which an approach similar to 

operating lease accounting 

applies using the same 

principle of consumption and 

related practical expedients as 

for lessee accounting. 

The lease term is the noncancellable 

period for which 

the lessee has contracted with 

the lessor to lease the 

underlying asset. It also 

includes any options to extend 

the lease when there is a 

significant economic incentive 

to exercise that option (e.g., 

bargain renewal) or a 

significant economic 

disincentive to not exercise the 

option (e.g., significant 

termination penalties). 

The measurement of lease 

assets and liabilities includes 

lease payments that are: 

In-substance fixed lease 

payments but structured 

as variable payments. 

Dependent on an index or 

rate. 

Expected to be payable 

under residual value 

guarantees. 

Variable payments based on 

usage or performance will not 

be included. 

The definition is carried 

forward substantially 

unchanged. However the 

"specified asset" and "right to 

control" principles that an 

entity would apply to 

determine whether a contract 

contains a lease have been 

revised. This may change some 

existing conclusions about 

whether an agreement is or 

contains a lease. 


.14 Although the project proposes changes to lessor accounting, it is the redeliberations 

relating to lessee accounting that are expected to have the most far-reaching 

implications. This Dataline discusses both the lessee and lessor proposed accounting 

models. 

.15 All board decisions noted in this Dataline are expected to be included in the revised 

ED; however, all decisions are tentative and therefore subject to change in conjunction 

with the drafting of the revised ED. A complete summary of the board's decisions on the 

leases project is available on the FASB's website at www.fasb.org and the IASB's website 

at www.ifrs.org. 


Redeliberations of the initial ED have been challenging for the boards as they seek to 

balance concerns from preparers about the cost and complexity of applying the 

proposals and demands from financial statement users to improve the usefulness of 

financial information on leases. The boards have remained committed to a largely 

converged solution and to a model under which lessees recognize lease assets and 

liabilities on their balance sheets — one of the core objectives of the project. However, 

other areas of redeliberations led to a compromise between conceptual purity and 

practical application. The most significant of these relates to the boards' objective to 

remove the existing bright-lines in current lease accounting with both boards failing 

to find a one-size-fits-all solution. The "dual model" approach for both lessees and 

lessors, while clearly a pragmatic solution, will most certainly attract significant 

debate in the comment letter process. This debate will include both whether there 

should be a dividing line and, if so, where it should be drawn. 

Summary of the boards' redeliberations 

Lessee expense recognition pattern 

.16 The initial ED implicitly treats all leases as financing transactions with the 

combination of amortization of the right-of-use asset, typically on a straight-line basis, 

and interest expense, calculated using the effective interest rate method in the aggregate 

creating an accelerated expense recognition pattern. Both preparers and users of 

financial statements across a wide range of industries had significant concerns about this 

front-loaded expense recognition pattern and the effect on key ratios of separately 

presenting amortization expense and interest expense, rather than presenting a 

combined rent expense within operating expense. 

.17 After much debate the boards tentatively decided there should be a distinction in the 

expense recognition pattern, with a straight-line pattern (the "single lease expense 

approach" or "SLE") for some leases, and the initial ED's front-loaded pattern (the 

"interest and amortization approach" or "I&A") for others. The determination of which 

approach to apply is based on a "principle" of consumption with a practical expedient 

based on the nature (property or non-property) of the underlying asset. 

.18 Although the lease expense recognition patterns would be different, both approaches 

would require the right-of-use asset and lease liability to be recorded on the balance 

sheet, except for leases meeting the definition of "short-term" (defined as a maximum 

possible term of less than 12 months). The liability would be initially measured at the 

present value of the lease payments and subsequently measured at amortized cost using 

the effective interest method. The right-of-use asset would initially be measured at an 

amount equal to the lease liability plus initial direct costs. 


.19 However, the I&A approach requires interest expense (relating to the lease liability) 

and amortization expense (relating to the right-of-use asset) to be reported separately in 

the income statement, consistent with the initial ED. In contrast, the SLE approach 

requires the lessee to allocate total lease payments, including initial direct costs, evenly 

over the lease term, irrespective of the timing of lease payments, to calculate the periodic 

straight-line expense. Interest expense relating to the lease liability would be recognized 

in the same way as under the I&A approach. However, the right-of-use asset 

amortization expense would be a balancing figure, calculated as the difference between 

the periodic straight-line expense and the interest cost on the lease liability. Amortization 

of the right of use asset and interest relating to the lease liability would be reported in a 

single item in the income statement — "lease expense." 

.20 It is presumed that leases of property — defined as land and/or a building or part of a 

building — should be accounted for using a straight-line expense recognition pattern. 

This presumption is overcome if: 

or 

The lease term is for the major part of the underlying asset’s economic life; 

The present value of the fixed lease payments accounts for substantially all of the 

fair value of the underlying asset. 

.21 For leases of assets other than property — such as equipment — it is presumed that 

lessees should apply the approach proposed in the initial ED, unless: 

or 

The lease term is an insignificant portion of the underlying asset’s economic life; 

The present value of the fixed lease payments is insignificant relative to the fair 

value of the underlying asset. 

.22 The following decision tree depicts the emerging lessee accounting model under the 

revised ED: 


Potential outcomes for lessees 

Start 

Is the 

arrangement 

a lease, or does the 

arrangement contain 

a lease? 

No 

Apply non-lease 

accounting guidance. 

Yes 

Note on lessee decision tree: Under 

both the SLE approach and the I&A 

approach, all leases (except for short-term 

leases) are included on the balance sheet. 

Is the 

lease term 

for a major part of the 

underlying asset’s economic 

life or is the PV of the fixed 

lease payments substantially 

all of the fair value of 

the underlying 

asset? 

Yes 

No 

Yes 

Is there a 

purchase option 

(with significant 

economic incentive) or 

obligation to 

purchase? 

No 

No 

Is the 

lease a 

"short-term" 

lease? 

Is the leased 

asset property? 

No 

Yes 

Yes 

Accounting similar to 

purchase of an asset. 

Apply existing 

operating lease 

accounting model. 

Is the 

lease term for 

an insignificant portion 

of the underlying asset’s 

economic life or is the PV 

of the fixed lease payments 

insignificant relative 

to the FV of the 

underlying 

asset? 

Yes 

No 

Apply I&A 

approach 

Apply SLE 

approach 

Apply SLE 

approach 

Apply I&A 

approach 


.23 The following illustration depicts common lease examples and which expense 

recognition approach will apply to each type of lease. In determining which approach to 

apply, significant judgment will be required for those property leases that fall on the 

borderline of significant (e.g., a 30-year lease of commercial real estate) and those 

equipment leases that fall on the borderline of insignificant (e.g., a 5-year vessel lease). 

.24 General concepts — Under the revised ED, lessees of property (including land and 

buildings) would be presumed to be eligible to apply SLE, unless factors suggest 

otherwise. Lessees of non-property (such as equipment) would be presumed to apply the 

I&A approach, unless factors suggest otherwise. 


The decision to introduce a new dividing line into the model is likely to generate 

significant interest and debate, given that one of the project's objectives was to 

remove the existing "bright-lines" between operating and capital leases. For lessees of 

non-property leases, such as equipment, the I&A approach will create the same frontloaded 

expense and financial ratio concerns that were raised when the initial ED was 

published for comment. 

.25 Impacts of different models — The proposal in the initial ED for all lessees to apply a 

financing approach sparked debate among a number of constituents who were concerned 

with the effect the proposals would have on earnings and key ratios. Users had mixed 

views about whether the expense recognition pattern would provide a better 

representation of the effects of leases or create a further divergence between profit and 


loss and cash flows. After much back and forth, the boards determined they could 

support moving away from applying a financing approach to all leases. 

.26 The diagram below illustrates the changes in a lessee's financial statements from the 

existing operating lease accounting to the initial ED and the revised ED (assuming no 

changes in lease assumptions or transition related impacts). 

Changes in expense recognition patterns from existing operating lease accounting 

Balance Sheet Proposed Model Single Lease Interest and Amortization 

in the Initial ED Expense Approach Approach 

Assets 

* 

Liabilities 

Income statement 

Lease expense 

Amortization 

Interest expense 

EBIT 

EBITDA 

EBITDAR 

EPS 

Cash flow statement 

Cash from ops 

Cash from finance 

*A smaller arrow indicates that although there is a change from existing operating lease accounting, 

the change is smaller than under the proposed model in the initial ED. 

.27 Application issues — Having two models and applying the practical expedient to 

different fact patterns is also expected to add fuel to the debate. Some of the questions 

this could generate include: 

What is meant by "substantially all"? What is meant by "insignificant"? Are they 

purely quantitative thresholds (e.g., 90%, 10%) or is a qualitative analysis needed? 

Does this fundamentally create new bright lines? 

Should one interpret "property" to mean land or a building, or part of a building 

("international view") or to include a broader "real estate" definition ("U.S. view") 

that includes "integral equipment," such as cell towers? 

Will "fragmentation" between property and non-property items included in the 

same arrangement be required? For example, if there is a single contract with more 

than one lease element (such as land, building, and equipment) is there a 

requirement to break out each respective component and evaluate it separately, 

potentially with a different expense recognition pattern for each? 


In applying the practical expedient to long-term land leases (e.g., those greater than 

25 years), a quantitative analysis would likely indicate the lessee is obtaining 

"substantially all" of the fair value of the underlying asset and would imply that the 

I&A model is appropriate. However, wouldn't this be inconsistent with the 

underlying concept of consumption? 

How would the practical expedient apply in re-lease situations? For example, how 

would one account for a 5-year lease granted in year 45 of an asset's 50-year life? 

Lessor accounting 

.28 Similar to lessee accounting, the boards are proposing that two types of approaches 

apply to leases to be accounted for by lessors. The decision is between an approach that is 

similar to the straight-line operating lease accounting of today, with no derecognition of 

the underlying asset or gain/loss on lease commencement, and the "receivable and 

residual approach." After considerable debate, the boards concluded that the dividing 

line between the two approaches should be the same as for lessees (i.e., it would be based 

on an underlying consumption concept with practical expedients). The following decision 

tree depicts the emerging lessor accounting model under the revised ED. 

Start 

Is the 

arrangement 

a lease, or does the 

arrangement contain, 

a lease? 

No 

Apply other 

accounting guidance 

(presumably revenue 

recognition guidance) 

Yes 

Is 

there a purchase 

option (with a significant 

economic incentive) 

or obligation to 

purchase? 

Yes 

Accounting similar to 

sale of the underlying 

asset 

No 

Is the lease term 

for a major part of the 

underlying asset’s economic life 

or is the PV of the fixed lease 

payments substantially all of the 

fair value of the 

underlying asset? 

Yes 

Is the leased 

asset property? 

No 

Is the 

lease term for 

an insignificant portion of 

the underlying asset’s 

economic life or is the PV of the 

fixed lease payments insignificant 

relative to the FV of the 

underlying 

asset? 

Yes 

No 

Yes 

No 

Apply R&R 

approach 

Apply 

approach 

similar to 

operating 

lease 

accounting 

Apply 

approach 

similar to 

operating 

lease 

accounting 

Apply R&R 

approach 


The revised dual lessor accounting approach 

.29 When the lessee does not have a right to acquire or consume more than an 

insignificant portion of the underlying asset (typically presumed for leases of property), 

the lessor will apply an approach similar to existing operating lease accounting. Under 

this approach: 

The underlying leased asset remains on the balance sheet of the lessor. 

No lease receivable or gain/loss is recorded at lease commencement. 

Rental revenue is recognized on a straight-line basis over the terms of the respective 

leases. 

Unbilled rents receivable represent the cumulative amount by which straight-line 

rental revenue exceeds rents currently billed in accordance with the lease 

agreements. 

.30 When a lease gives a lessee the right to acquire or consume more than an 

insignificant portion of the underlying asset (typically presumed when the underlying 

asset is not property), the lessor will apply the receivable and residual approach. Under 

this approach, the lessor at lease commencement will: 

Derecognize the entire carrying amount of the leased asset. 

Recognize a receivable measured at the present value of the remaining lease 

payments, discounted at the rate the lessor charges the lessee. 

Recognize a residual asset, measured as an allocation of the carrying amount of the 

underlying asset. This comprises a gross residual asset and a deferred profit 

component. 

.31 Under the receivable and residual approach, day one profit is recognized on the 

portion of the underlying asset conveyed to the lessee via a right-of-use. This profit would 

be measured as the difference between the present value of the lease receivable and the 

cost basis of the underlying asset allocated to the lease receivable. Any profit on the 

portion of the underlying asset retained by the lessor (related to the lessor's residual 

interest in the leased asset) would be deferred and only recognized when the residual 

asset is sold or re-leased. If the underlying asset is re-leased, a new lease calculation for 

profit to be recognized over the new lease term is performed, with a portion of the 

remaining profit deferred. If the underlying asset is sold at the end of the lease term, the 

remaining profit would generally be recognized. 

.32 The lease receivable is subsequently measured using the effective interest rate 

method and would be subject to an impairment assessment. Specifically, for lease 

receivables, lessors could elect to either fully apply the "three-bucket" model proposed in 

the Financial Instruments project or apply a simplified approach. Under the simplified 

approach, lease receivables would have an impairment allowance measurement objective 

of lifetime expected credit losses at initial recognition and through the lease receivables' 

life. 

.33 General concepts — Many respondents to the revised ED are likely to challenge the 

boards' decision to apply a lessor model that is symmetrical with lessee accounting. For 

example, they may question whether: 


Consistency with the revenue recognition proposals (e.g., when license revenue is 

recognized) would be preferable. 

A property/non-property distinction is appropriate (e.g., for multi-tenant 

equipment leases, such as satellites and telecommunication antennas, which have 

many characteristic in common with property). 

A dividing line based on the lessor's business model would better reflect the 

economics. 

It is intuitive that the leased asset (or at least a portion of it) appears on both the 

lessee and lessor's balance sheets, when the lessor applies the operating lease 

accounting approach. 

.34 Application issues — Given that the principle for determining which lessor 

accounting approach should be used is the same as that used for determining lessee 

accounting, the application issues for lessors are likely to mirror those for lessees. These 

include what is significant and insignificant, how broad the term "property" should be 

defined, application of the guidance to arrangements involving multiple assets, whether a 

fragmentation approach should be used, and dealing with re-lease situations. 

.35 Similar questions to those facing lessees also exist in applying the practical expedient 

to long-term land leases (e.g., those greater than 25 years). The economic result would 

likely indicate the present value of the lease payments made by the lessee would account 

for substantially all of the fair value of land and would imply that the "receivable and 

residual approach" is appropriate and the lessor would recognize day one profit. 

However, this result appears on its face to be inconsistent with the underlying concept of 

consumption for land leases. 


Perspectives on the proposals relating to day one profit recognition are likely to vary 

between different types of lessors. For example, current finance lessors that recognize 

their margin over the lease term may question whether up-front revenue best reflects 

their business model. In contrast, lessors of existing sales-type leases may question 

the requirement to defer all of the profit relating to the residual asset until the end of 

the lease. This is because they have in substance sold the entire underlying asset and 

in many cases priced the majority, if not all, of the residual risk into the existing lease. 

Further, the deferral of any profit relating to the cost allocated to the residual asset 

raises the question of whether the deferred profit meets the conceptual definition of a 

liability. 

.36 For lessors that have contracts that fall under the receivable and residual approach, 

there are also some areas of potential concern relating to the accounting for renewal 

options and variable/uncertain payments. First, the potential inclusion of extension 

options initially thought to meet the "significant economic incentive" threshold is viewed 

by some as creating a potential for over recognition of profit by lessors at lease 

commencement. Second, in cases where the lease entirely or significantly comprises 

variable lease payments that are not based on a rate or an index, it is not clear how the 

model would be applied. Derecognition of the asset with no receivable recognized would 

seem to result in a loss, even when no real economic loss is expected to be realized on the 

contract. A concept of "in substance fixed lease payments," which may alleviate this 

scenario, was briefly discussed but has not yet been clearly articulated — a matter that 

will likely be a focus of the staff when drafting the revised ED. 

.37 The tentative decision reached by the boards is that a lessor can elect to assess a lease 

receivable for impairment under the "three-bucket" model proposed in the boards' 


Financial Instruments project. However, as part of that project the boards continue to 

debate the proposal to apply a three-bucket model, which may affect lessor receivable 

impairment accounting. It is unclear whether the boards will reach a converged solution. 

See In brief 2012-37, FASB makes key decisions about the revised impairment model for 

financial assets for additional details. 

Lessors of investment property 

.38 The initial ED contained a scope exclusion from the proposed model to allow lessors 

of investment properties accounted for at fair value to continue to use a model similar to 

today's accounting for operating leases. In light of significant computational issues with 

respect to lessor accounting for portions of assets (e.g., one floor in a multi-story office 

building or one store location in a shopping mall), this scope exclusion was later 

expanded to lessors of all investment properties, irrespective of whether the leased 

investment property was accounted for at fair value. 


The boards' more recent decision overturns this previous scope exclusion for all 

investment property. Similar results are expected in most cases because most lessors 

of investment property will not apply the receivable and residual approach. Because 

of application of the "consumption of the underlying asset" principle, they will 

account for the leases using an approach similar to existing operating lease 

accounting. The revised ED is also expected to clarify the interaction between the 

leases standard and any requirements in IFRS or U.S. GAAP to measure some 

investment property at fair value. However, certain longer dated land leases or other 

property leases may qualify for the receivable and residual approach (i.e., 

derecognition, gain/loss). Today, these property leases may only qualify for sales type 

lease accounting under U.S. GAAP (e.g., because the leased asset is not carried at fair 

value due to builder profit or other reasons) if there is an automatic transfer of title. 

This may represent a change for some property lessors reporting in the U.S. There is 

no similar preclusion under current IFRS. 

Lease term 

.39 The threshold for inclusion of extension options in the lease term in the initial ED 

was "more likely than not" (a greater than 50% likelihood of renewal). A common theme 

in the comment letters was that this threshold was too low and would be highly 

subjective and potentially volatile in practice. When coupled with the requirement to 

reassess every reporting period, it would also be very costly to implement and create 

unnecessary volatility. 


One of the primary reasons for including extension options, and not limiting the 

accounting to the non-cancellable lease term, is to avoid the potential for structuring 

opportunities. For example, one could theoretically structure a 20 year lease as a 

daily lease with 20 years worth of daily renewals. In practice, such an arrangement is 

unlikely and potentially costly (as the lessor would want to be compensated for the 

related uncertainty and would need to recover tenant specific improvements in a real 

estate lease). 


.40 The revised ED will raise the threshold to include extension options that provide "a 

significant economic incentive for an entity to exercise an option to extend the lease, or 

for an entity not to exercise an option to terminate the lease." 


In reassessing the threshold, the boards made a practical compromise that is less 

complex and more operational while still providing reasonable protection against 

structuring concerns. The higher threshold will generally result in shorter lease terms 

and lower amounts recognized by lessees on the balance sheet than would have 

resulted under the initial ED. The revised threshold is also more consistent with 

today's treatment of including renewal periods in the lease term only when they are 

"reasonably certain" of being exercised, which is well understood in practice and 

would be smoother in transition. 

.41 A list of indicators to help entities assess whether this threshold has been met is 

expected to be provided in the revised ED. These indicators will likely include the 

existence of substantive bargain renewal options and economic penalties if the lease is 

not renewed (e.g., direct penalty payments, tenant improvements with significant value 

that would be forfeited, or a lessee's guarantee of lessor debt related to the leased 

property). Management intent and past business practices are not expected to be 

sufficient to create a significant economic incentive. 


One question that has arisen is how the practical application of guidance on 

determining the lease term under the revised ED may differ from current guidance 

and whether the lease term may actually be longer or shorter. For example, consider 

a flagship store with a fair value renewal term that is considered a "mission critical 

asset." The conclusion as to whether the renewal option is "reasonably certain" of 

being exercised under today's guidance, and whether a significant economic incentive 

threshold has been met may be different, depending on the indicators ultimately 

provided in the revised ED. 

.42 The lease term would be reassessed when there is a significant change in one or more 

of the indicators such that the lessee would then have, or no longer have, a significant 

economic incentive to exercise an option or terminate the lease. 


While changes will likely be less frequent under the revised ED, the requirement to 

reassess the lease term still is a significant change from the "set it and forget it" model 

used today. From a practical perspective, changes as a result of a reassessment will 

likely be more aligned with the timing of actual business decisions. However, the 

requirement to reassess requires judgment. The ongoing systems and processes that 

will need to be maintained to produce the data to make those judgments will likely 

add significantly to the cost of implementation, particularly for those entities with a 

significant portfolio of lease contracts. 

.43 The definition of lease term will be consistent for both lessees and lessors. The 

boards acknowledged that different conclusions could be reached related to the same 

lease, as lessees and lessors may have different levels of information or make different 

judgments. 



Judgment will be required to determine whether, and when, a significant economic 

incentive exists. For example, consider a lease of factory space with a 10 year initial 

lease term and a five year renewal option. At lease commencement the lease term was 

determined to be 10 years because no factors indicated that the lessee had a 

significant economic incentive to exercise the renewal option. In year two of the lease, 

the lessee makes plans for significant leasehold improvements, such as embedding a 

piece of unique equipment in the factory space. The lessee includes the expenditure 

in its capital budget in year two and expects the improvement project to begin in year 

four and be completed in year five. The entity will need to consider when the lease 

term would be reassessed — would it be when the expenditure is included in the 

budget, when the first dollar is spent, when the project is completed, or somewhere in 

between? 

Variable/uncertain cash flows 

.44 The requirement for all variable lease payments to be measured using a probabilityweighted 

approach would be eliminated. Instead, the following variable lease payments 

will be included in the measurement of lease obligations and assets: 

All contingencies that are based on a rate or an index. 

Payments where the variability lacks economic substance (i.e., an anti-abuse 

provision designed to include "disguised" or "in-substance" fixed lease payments). 

For lessees, any portion of residual value guarantees that are expected to be paid, 

except for amounts payable under guarantees provided by an unrelated third party. 

Lessors, on the other hand, would not recognize amounts expected to be received 

relating to residual value guarantees until the end of the lease. 


The boards' revised proposal would strike a balance between the complexity of 

including contingent payments and the structuring concerns that arise if all 

contingent payments were excluded. The elimination of the requirement to use a 

probability-weighted approach will also improve operationality. When coupled with 

the revised threshold for inclusion of term extension options, the elimination of usage 

and performance-based contingencies (discussed below) will greatly reduce 

complexity as compared to the initial ED. 

.45 Variable lease payments that are usage or performance-based (e.g., based on the 

number of miles a leased car is driven or the level of tenant sales) would be excluded in 

measuring lease assets and lease liabilities, unless the variable lease payments are 

"disguised" or "in-substance" fixed lease payments (i.e., an anti-abuse provision as 

described above). 


Determining whether a contingent payment is a "disguised" or an "in-substance" 

fixed lease payment will likely require a significant amount of judgment. For 

example, consider leases that have no, or nominal, fixed payments and require 

contingent lease payments based on a percentage of sales (e.g., a retail store) or based 

on output (e.g., wind or solar farms). If such payments are entirely excluded, such 

contingent payment structures would have no on-balance sheet accounting by the 


lessee. Clearly both parties are entering into the lease with an expectation of 

payments being made, so should some amount of the contingent payment be 

considered an "in-substance" fixed lease payment? If so, what amount? Some factors 

to consider may be whether this arrangement is consistent with usual business terms 

offered by the lessor, whether a minimum level of sales or output is required under 

the contract, how the arrangement terms compare with standard industry practice, 

and why the contract pricing terms have been structured in this manner. It is not 

clear whether this issue will be addressed in the revised ED or will be discussed as 

part of redeliberations that take place after comments are received on the revised ED. 

.46 "Term option penalties" would be included or excluded in the measurement of lease 

assets and lease liabilities in a manner that is consistent with the accounting for options 

to extend or terminate a lease. For example, if a lessee would be required to pay a 

termination penalty if it does not renew the lease and the renewal period is excluded 

from the lease term, then that penalty should be included in the recognized lease 

payments. 

.47 Variable lease payments will require reassessment as rates and indices change, which 

may be as often as each reporting period. Reassessing lease payments based on a rate or 

index will require lessees to re-measure their right-of-use asset and lease obligation each 

time rates and indices change. Lessees would account for this change in the income 

statement when it relates to a past or current accounting period and as an adjustment to 

the right-of-use asset when it relates to a future period. Lessors would account for all 

changes in the right to receive lease payments due to changes in a rate or an index 

immediately in the income statement. 


The requirement for lessors to immediately account for in the income statement all 

changes in the right to receive lease payments due to movements in a rate or an index 

represents a significant change from the current models — irrespective of whether the 

lessor is using an approach similar to existing operating lease accounting or the 

receivable and residual approach. For example, in a 20-year real estate lease with 

rents that increase with changes in the Consumer Price Index annually over the base 

year, a change in the index after year 1 impacts years 2-20 and the present value of 

the differential hits the income statement in one lump sum. This is not symmetrical 

to lessee accounting and could result in significant volatility in, and front loading of, 

earnings relative to the contract rents. 

Definition of a lease 

.48 The initial ED carried forward the definition of a lease in existing guidance, subject to 

some relatively minor amendments. Perhaps the most surprising issue to the boards that 

came out of the comment letters was the level of concern raised about carrying this 

forward into the proposals and the extent of application issues in applying the current 

lease definition that respondents identified. 

.49 The boards acknowledged during redeliberations that there may be many more 

multiple-element arrangements that contain an embedded lease than originally expected, 

which could have substantially increased the complexity and cost of applying the initial 

ED. Some common agreements that may contain an embedded lease are: 


Time-charter contract: A time charterer enters into a contract with a ship owner 

for the use of a named cargo ship for 5 years. Under the time charter, cleaning 

services relating to the cargo space or other relevant services, such as overseeing the 

loading and unloading of cargo and management of cargo at sea, are the 

responsibility of the ship owner in addition to maintenance and overhaul. Food and 

water for the captain and crew are also provided by the owner. The charterer may be 

chartering the ship either to carry its cargo or cargo owned by third-parties. The 

charterer pays a daily or monthly hire rate, based on the market price at the date of 

the contract, for the use of the ship (including the captain) and also pays for the 

costs of all fuel consumed by the ship and all port fees. Additionally, the time 

charterer pays all cargo loading and unloading charges. 

Analysis — An assessment of whether this arrangement is a contract for 

transportation services or includes an embedded lease of the cargo ship is required. 

The conclusion will depend on whether the instructions provided in the time 

charter contract are deemed to convey the right to control the ship to the time 

charterer even though the captain and crew are provided by the ship owner. 

Parts supply contract: Purchaser P and Supplier S enter into a parts supply 

agreement for the lifetime of the finished product concerned. S uses equipment 

(that is owned by S) that can only be used to manufacture the parts required by P. 

The equipment is identified in the agreement and S could not use an alternative 

asset to manufacture the parts. The estimated capacity of the equipment is 500,000 

units, which corresponds to the total estimated production of units over the 

equipment's life cycle. P takes all of the output produced by S using the equipment. 

Analysis — An assessment of whether this arrangement is a contract for the 

supply of parts or includes an embedded lease of the equipment used to 

manufacture the parts is required. The conclusion will depend on whether P has 

the right to control the equipment based upon the extent of P's involvement in the 

design of, operation of, and sourcing of the raw materials needed for, the 

equipment used to manufacture the parts. 

.50 Under current guidance, a conclusion that a contract for services contains a lease 

would not have a significant accounting impact for lessees or lessors if the lease is 

classified as an operating lease. However, this would have changed significantly under 

the initial ED. The judgment about whether a lease exists and the allocation of contract 

consideration between the lease and non-lease elements would be much more important 

for these so-called "embedded leases." 


Under current guidance, any embedded lease within an arrangement would often be 

considered an operating lease. However, many lessees do not separate the embedded 

lease because the accounting for an operating lease and a service/supply arrangement 

is generally the same (i.e., there is no recognition on the balance sheet and straightline 

expense is recognized over the contract period). This practice will change with 

the proposal to recognize leases on the balance sheet. Accordingly, there is likely to be 

a greater focus on identifying whether a component of an arrangement meets the 

definition of a lease. 

.51 During redeliberations, the boards affirmed the proposal in the initial ED to define a 

lease as “a contract in which the right to use a specified asset (the underlying asset) is 

conveyed, for a period of time, in exchange for consideration.” 



The definition of a lease and whether an agreement is or contains a lease will become 

a significant area of focus for both lessees and lessors. For potential lessees, it will 

mean the difference between contracts reflected on the balance sheet (other than 

short-term leases) under the new lease model and contracts accounted for off-balance 

sheet as executory contracts. This is not an all or nothing evaluation — the contract 

may include both a lease and a service (or non-lease executory cost) component, 

requiring the apportionment of contract consideration. For potential lessors, it will 

determine whether income recognition relating to some or all of a contract is 

governed by the lease model or by the general revenue recognition model and how 

contract assets should be presented and measured. 

.52 The boards also reaffirmed the "specified asset" and "right to control" principles that 

an entity would apply to determine whether a contract contains a lease. This requires 

assessing whether: 

a. The fulfillment of the contract depends on the use of a specified asset; and 

b. The contract conveys the right to control the use of a specified asset for a period 

of time. 

.53 However, while the boards reaffirmed these two principles, the revised ED would 

change the guidance for applying them in determining whether an arrangement contains 

a lease or is a service contract in its entirety. The changes are expected to address specific 

problems that exist in applying the current lease definition to certain types of 

transactions (e.g., power purchase arrangements) and better align the right to control 

concept with other convergence projects, such as revenue recognition and consolidation. 


There is an expectation that the boards will continue to revise the wording used to 

define a lease when drafting the revised ED. Although, the drafting revisions may 

appear minor, we think that they may change whether certain arrangements with 

significant service elements are within the scope of lease accounting. In addition, 

although the boards left the core definition of a lease largely intact, potentially 

significant interpretive guidance is expected, which may change some of the existing 

conclusions from those reached under today's guidance. 

Transition 

.54 The revised ED is expected to require either a full retrospective approach or allow 

both lessees and lessors options to elect certain reliefs and apply alternative transition 

approaches. The reliefs are intended to alleviate the burden of applying a full 

retrospective approach (e.g., providing simplifications to transition discount rate 

assumptions) and, for lessees, mitigate the front-loaded expense recognition pattern that 

would result from the transition approach proposed in the initial ED. If elected, these 

reliefs would be applied to all leases that are outstanding as of the beginning of the 

earliest comparative period presented. 

.55 All evidence available to the lessees and lessors through the effective date can be used 

to measure the lease term and variable lease payments at transition. For example, if a 

lessee exercised a renewal option prior to the effective date of the new guidance, it could 

reflect that throughout the comparative periods without having to determine whether 

there was a significant economic incentive to extend the term of the lease in prior periods. 

For leases with payments based on an index or rate, this would mean using the actual 


index or rate that was applicable for historical periods and the index or rate as of the 

effective date for future periods when measuring lease assets and lease liabilities at 

transition. 


It is unclear how lessors that apply existing operating lease accounting but will not 

qualify for the receivable and residual approach will account for transition related 

matters (e.g., changes in the accounting for variable lease payments and estimates of 

lease term). The boards have not commented if this issue will be addressed in the 

revised ED or if it will be discussed as part of redeliberations that take place after 

comments are received on the revised ED. 

.56 When lessees and lessors elect to apply alternative transition approaches, lease 

prepayments and lease accruals relating to existing operating leases with uneven lease 

payments could lead to an adjustment to the right-of-use asset at the transition date (for 

lessees) and a transition adjustment to the cost basis in the underlying asset that is 

derecognized (for lessors applying the receivable and residual approach). 


When a lessee has an existing operating lease that qualifies for the I&A expense 

recognition approach under the revised ED and the lessee applies the modified 

retrospective approach to transition, there will be lease expense recorded as an 

adjustment directly to retained earnings at transition, rather than in the income 

statement. This is expected to provide entities with higher total profits over the 

remaining term of the lease than would be the case under the existing operating lease 

accounting model, under a full retrospective approach at transition, or when the SLE 

approach is applied under the revised ED. For lessors, adjusting the cost basis of the 

underlying asset for any prepaid or accrued lease payments will affect both the 

"deferred" and "day 1" profit recognized upon transition as an adjustment to 

beginning retained earnings. Conceptual concerns may exist as to why any prepaid or 

accrued lease payments arising after the inception of the lease should affect the 

calculation of deferred profit for a lessor applying the receivable and residual 

approach. 

.57 Specific transition guidance is also provided for certain lease arrangements. This 

includes the: 

Elimination of leverage lease accounting with a leverage lease lessor required to 

apply the general lessor transition approach. 

Continuation of existing sale and leaseback accounting for transactions that resulted 

in capital lease classification. 

Re-evaluation of the sale conclusions based on the criteria in the proposed revenue 

standard for sale and leaseback transactions that resulted in operating lease 

classification or where the sale recognition criteria previously were not met. If the 

new revenue criteria are met, a seller/lessee would measure lease assets and lease 

liabilities in accordance with the core guidance in the revised ED and would 

recognize any deferred gain or loss in opening retained earnings at transition. 



Seller/lessees that consummated a sale and leaseback transaction under existing U.S. 

GAAP that resulted in an operating lease are likely to be concerned with the proposed 

transition accounting. This is because any deferred gain on the original sale and 

leaseback will be reclassified into retained earnings at the transition date and will not 

provide the lessee with any future income over the remaining term of the lease. 

Leverage lease lessors are also likely to raise concerns with the proposal to eliminate, 

rather than grandfather, the accounting for leverage leases that exist at the transition 

date. 

.58 All lessees and lessors will need to consider the deferred tax implications that will 

arise on transition as a result of changes that will be made to both the balance sheet and 

income statement presentation of existing leases. The effect on retained earnings of these 

transition related deferred tax adjustments could be significant. 

.59 The boards decided not to provide relief for leases outstanding at the date of 

transition that expire prior to the effective date of the new standard or for arrangements 

that were grandfathered in accordance with the transition requirements in ASC Topic 

840. Further, arrangements that meet the definition of a lease today, but do not meet the 

definition of a lease in the revised ED would cease applying lease accounting on the 

transition date. The arrangement would be reclassified under other existing guidance 

(e.g., revenue recognition) and a cumulative catch-up adjustment would be recognized in 

retained earnings. 

.60 Notwithstanding the lack of grandfathering for determining whether an arrangement 

is, or contains, a lease, and consistent with the initial ED, the boards will require a 

simplified transition for lessees and lessors with capital and finance leases under today's 

guidance. Lessees and lessors will continue to recognize existing carrying amounts at the 

beginning of the earliest comparative period presented, even when the lease contract 

includes terms relating to option periods and variable lease payments. 


We believe the boards intend for the definition of a lease to be applied retrospectively 

— that is, any contracts in place as of the beginning of the earliest period presented 

that are determined to be leases under the revised definition at the transition date 

would follow the new rules. The lack of grandfathering for existing leases will mean 

that extensive data-gathering will be required to inventory all contracts. For each 

lease, a process will need to be established to capture information about lease term, 

renewal options, and fixed and contingent payments. The information that will be 

required under the revised ED will typically exceed that needed under current GAAP. 

Depending on the number of leases, the inception dates, and the records available, 

gathering and analyzing the information could take considerable time and effort. 

Beginning the process early will help to ensure that implementation of the final 

standard is orderly and well controlled. Companies should also be cognizant of the 

proposed model when negotiating lease contracts between now and the effective date 

of a final standard. 


The path forward 

.61 The boards are planning to issue the revised ED at the end of November 2012, 

however, this may slip into early 2013. Issuance of a final standard, although targeted for 

2013, may well slip into 2014. Although the effective date has not yet been discussed, it 

will likely not be before 2016. Preparers will need to apply the guidance to all leases 

existing as of the beginning of the earliest comparative period presented. 

Questions 

.62 PwC clients who have questions about this Dataline should contact their engagement 

partner. Engagement teams that have questions should contact members of the Leasing 

team in the National Professional Services Group (1-973-236-7805). 


Appendix: Other key areas of redeliberations 

Topic Initial ED Revised ED PwC observations 

Build-to-suit 

leasing 

transactions 

Not covered Will not be covered When a lessee is involved in a build-to-suit leasing transaction, it would no 

longer be required to account for that lease during the construction period 

between the inception and commencement dates of the lease. This is because the 

revised ED will require accounting for a lease contract from its commencement 

date, rather than its inception date. This will significantly change current 

practice on accounting for build-to-suit leases in the United States under ASC 

840 as it will imply that the lease accounting guidance would only be applied 

once the underlying asset is available for use by the lessee. The financial 

statements would be required to disclose significant build-to-suit lease 

transactions prior to commencement of the lease. 

Further, in instances where payments are required prior to lease 

commencement, the lessee should recognize those amounts as prepayments and 

add them to the right-of-use asset at lease commencement. 

Business 

combinations 

Not covered 

Lessees and lessors should 

account for a lease acquired in a 

business combination as a new 

lease on the acquisition date. 

If the acquiree is a lessee, the 

acquirer should recognize a 

liability to make lease payments 

and a right-of-use asset. The 

acquirer should measure: 

As the lease contract acquired would be accounted for as a new lease, we believe 

that further clarification may be sought on applying the "consumption of the 

underlying asset" principle at the acquisition date to determine which 

accounting approach should be followed (e.g., I&A, SLE, etc.). Clarification may 

also be requested about whether initial assumptions should be updated (such as 

about extension options) when valuing leases upon acquisition or determining 

which approach to apply. If initial assumptions are updated at the acquisition 

date, the approach to apply (e.g., SLE or I&A for lessees) may change from that 

used on the lease commencement date. 

The liability as the present 

value of future lease 

payments at the acquisition 


The lessee's right-of-use 

asset recognized at the 

acquisition date should be 

adjusted for any off-market 

terms in the lease contract. 



If the acquiree is a lessor 

applying the receivable and 

residual approach, the acquirer 

should recognize a right to 

receive lease payments and a 

residual asset. The acquirer 

should measure: 

The right to receive lease 

payments as the present 

value of future lease 

payments at the acquisition 


The residual asset as the 

difference between the fair 

value of the underlying 

asset at the acquisition date 

and the carrying amount of 

the right to receive lease 

payments. 

If the acquiree has short-term 

leases, the acquirer should not 

recognize separate assets or 

liabilities related to the lease 

contract at the acquisition date. 

Cancellable 

leases 

Not covered 

Lease accounting should be 

applied only to leases for which 

enforceable rights and 

obligations arise. Cancellable 

leases include those that are 

cancellable by both the lessee 

and the lessor with minimal 

termination payments or 

include renewal options that 

must be agreed to by both the 

lessee and lessor. 

The intent of this provision is to ease the application burden for certain lessees 

(e.g., those in the construction industry) where shorter term lease contracts may 

not define a specific lease term but are structured on more of a "pay as you go" 

basis. However, one would need to determine whether there was an economic 

incentive to extend or not extend the term of the lease to evaluate whether the 

short-term lease exception could apply to these contracts. It is uncertain how 

many contracts will meet the definition of cancellable leases and be eligible for 

this relief. 



Contract 

modifications 

or changes in 

circumstances 

after the date 

of inception of 

the lease 

Not covered 

A change in circumstances other 

than a modification to the 

contractual terms of the 

contract that would affect the 

assessment of whether a 

contract is, or contains, a lease 

should result in reassessment. 

When there is a contract 

modification that results in a 

different determination as to 

whether the contract is, or 

contains, a lease, the original 

contract would be considered 

terminated and the modified 

contract would be accounted for 

as a new contract. 

While the need for reassessment upon a contract modification may be evident, 

changes in circumstances may be more challenging to identify. For example, a 

contract to use a specified rail car for five years will likely be a lease. However, if 

the contract is amended to provide a substantive substitution clause allowing the 

supplier to replace the rail car with a similar rail car at its discretion, the 

contract would be reassessed and might not be considered a lease. 

Contrast this with a situation where, at inception, the contract to use a rail car 

for five years includes a substitution clause. If the substitution clause is not 

substantive because, for example, the supplier does not have other rail cars on 

hand to swap out, the contract would likely be considered a lease. If the supplier 

later procures other rail cars, and thus the substitution clause becomes 

substantive, the contract would be reassessed and might not be considered a 

lease. 

Other changes in circumstances could include: situations where a leased asset 

becomes less unique such that it is no longer implicitly specified, or when there 

are changes in the value of the economic benefits provided by a leased asset or 

changes in other contracts relating to the inputs, processes, and outputs relating 

to the leased asset that result in a different conclusion as to a customer's ability 

to control the use of the asset. 

The reassessment would apply only to whether a contract is, or contains, a lease. 

Accordingly, if the contract is within the scope of lease accounting, the 

determination at lease commencement of which lease approach should be 

applied is not reassessed if there is a change in circumstances. 

The boards are not expected to provide guidance on how one would account for 

a modification to the contractual terms of a contract after inception that upon 

reassessment does not change the initial conclusion of whether an arrangement 

is, or contains, a lease. Examples of contract modifications are changing lease 

payments, and adding or removing extension options, purchase options, and 

residual value guarantees. 



Disclosure 

Lessees and lessors 

should disclose 

qualitative and 

quantitative 

information that (a) 

identifies and 

explains the amounts 

recognized in the 

financial statements 

arising from leases; 

and (b) describes 

how leases may affect 

the amount, timing 

and uncertainty of 

the entity’s future 

cash flows. 

Lessee's should disclose a 

reconciliation of the opening 

and closing balance of lease 

liabilities for both I&A and SLE 

leases, a single maturity analysis 

of the undiscounted cash flows 

related to all lease liabilities, 

and costs for the period relating 

to variable lease payments not 

included in the lease liability. 

Lessors should disclose a table 

of all lease-related income 

items, a reconciliation of the 

opening and closing balance of 

the right to receive lease 

payments and residual assets, 

and a maturity analysis of the 

undiscounted cash flows that 

are included in the right to 

receive lease payments. 

Although changes have been made to the disclosures to be required in the 

revised ED, constituents are likely to make similar comments to those raised on 

the initial ED. 

Companies are likely to consider the proposals overly burdensome, specifically 

the requirements to provide a number of reconciliations of balance sheet, 

income statement, and cash flow statement activity. 

Financial statement users may raise concerns about the piecemeal nature of the 

disclosures, questioning how intuitive it will be for users to put together the 

various pieces of disclosure to provide them with useful information about an 

entity's lease activities. These concerns were raised by some of the FASB 

members who are contemplating providing an alternative view in the revised 

ED. 

Finally, some may question how the disclosure proposals align with the FASB's 

thoughts in its recently issued discussion paper entitled the Disclosure 

Framework. 

Note: Listing is not inclusive of 

all required disclosures. 

Discount rate 

A lessee should use 

the incremental 

borrowing rate or, if 

it can be readily 

determined, the rate 

the lessor charges the 

lessee. 

A lessor should use 

the rate the lessor 

charges the lessee 

Lessees should discount lease 

payments using the rate charged 

by the lessor if known; 

otherwise, the lessee’s 

incremental borrowing rate 

should be used. 

Lessors should discount lease 

payments using the rate they 

charge in the lease. 

The discount rate should not be 

reassessed if there is no change 

in lease payments. 

Lessees would not be obligated to seek out the rate the lessor is charging in the 

lease. The rate the lessor is charging is more likely to be identifiable in 

equipment leases, particularly when the equipment may also be purchased 

outright. For other types of leases, including real estate leases with rents based 

on cost per square foot, the lessee rarely knows the rate the lessor is charging 

because it is typically not relevant to negotiations. 

In determining the incremental borrowing rate, the lessee uses a discount rate 

commensurate with a secured borrowing that the lessee could obtain to finance 

the purchase of the specific asset over a borrowing term consistent with the 

initial expected term of the lease (including any extension options that include a 

significant economic incentive to exercise). For example, if a company were 

entering into a lease of a property in Chicago with an assumed term of 10 years, 

it would use a rate consistent with a 10 year fixed rate secured borrowing for 



The discount rate is reassessed 

when there is a change in the 

lease payment due to: 

A change in the assessment 

of whether the lessee has a 

significant economic 

incentive to exercise an 

option to extend the lease or 

purchase the underlying 

asset. 

property located in Chicago. 

Private companies with no third party debt and group entities where lease 

arrangements are held in different subsidiary entities are likely to question what 

incremental borrowing rate to use if the lessee has no outstanding debt. We have 

heard from many preparers that they believe more guidance should be provided 

on how to assess the appropriate discount rate in these and similar 

circumstances. 

The exercise of an option 

that the lessee did not have 

a significant economic 

incentive to exercise. 

Embedded 

derivatives 

Not covered. 

A company should assess 

whether a lease contract 

includes embedded derivatives 

that should be separated and 

accounted for in accordance 

with applicable derivative 

guidance. 

This is not a substantial change from current practice under U.S. GAAP. 

Impairment Not covered. Lessees would follow existing 

guidance on impairment of 

long-lived assets when 

evaluating the right-of-use 

asset. 

For lease receivables, lessors 

could elect to either fully apply 

the "three-bucket" model or 

apply a simplified approach in 

which lease receivables would 

have an impairment allowance 

measurement objective of 

lifetime expected credit losses at 

A right-of-use asset accounted for under the single lease expense model would 

have a higher risk of impairment due to the fact that the asset balance would be 

higher than if the lease was accounted for under the I&A approach. This is 

because under the SLE approach, depreciation of the right-of-use asset is backend 

loaded to generate a total straight-line lease expense. 

The boards have yet to clarify if impairment testing can be done at a portfolio 

level or if it must be done on an individual lease basis. While a portfolio level 

test for leases with common characteristics (e.g., similar automobiles) may be 

possible, it may be challenging to apply such an approach to assets with different 

characteristics (e.g., different retail store locations). For retailers with a 

significant number of leased stores, performing an impairment test on a lease by 

lease basis may be a significant undertaking. 



initial recognition and through 

the lease receivables' life. 

Lessors would follow existing 

guidance for fixed assets when 

evaluating the residual asset. 

The “three bucket” impairment model for lease receivables is currently under 

discussion by the boards. The boards plan to meet in the fall of 2012 to further 

discuss the proposed model. It remains unclear whether the boards will achieve 

convergence on the impairment model. 

Inception vs. 

commencement 

The lease is 

measured at lease 

inception (i.e., the 

earlier of the date of 

signing the lease 

agreement or the 

date of commitment). 

However, the asset 

and corresponding 

liability would not be 

recorded until the 

commencement date 

of the lease, which is 

the date on which the 

lessor makes the 

leased asset available 

to the lessee. 

The lessee and lessor will 

initially measure and recognize 

the lease assets and lease 

liabilities (derecognize any 

corresponding assets and 

liabilities) at the date of 

commencement of the lease. 

This is the date on which the 

lessor makes the underlying 

asset available to the lessee. 

The decision to measure and record the lease asset and liability on the same date 

would simplify the guidance. However, at lease inception, lessees would still be 

required to determine if an onerous lease contract exists and account for it in 

accordance with existing guidance. 

Initial direct 

costs 

Initial direct costs are 

required to be 

capitalized and 

added to the lessee's 

right-of-use asset. 

Initial direct costs are 

defined as 

recoverable costs 

directly attributable 

to negotiating and 

arranging a lease. 

Initial direct costs are required 

to be capitalized and added to 

the lessee's right-of-use asset 

and to the amount recognized as 

the lessor’s lease receivable. 

Initial direct costs are defined as 

costs that are directly 

attributable to negotiating and 

arranging a lease that would not 

have been incurred had the 

lease transaction not been 

entered into. 

Although the boards did not revisit this issue after moving to a dual model 

approach, we understand that this guidance applies to both lessees and lessors 

irrespective of which model is used. 



In substance 

purchases/sales 

An entity would not 

apply the guidance to 

contracts that meet 

the criteria for 

classification as a 

purchase or sale of an 

underlying asset. No 

guidance for 

distinguishing a lease 

of an underlying 

asset from an insubstance 

purchase 

or sale of that asset 

was provided. 

A contract represents 

a purchase or sale if, 

at the end of the 

contract, an entity 

transfers to another 

entity control of the 

entire underlying 

asset and all but a 

trivial amount of the 

risks and benefits 

associated with the 


asset, such as with an 

automatic transfer or 

bargain purchase 

option. 

No guidance for distinguishing 

a lease of an underlying asset 

from an in-substance purchase 

or sale of that asset has been 

discussed during redeliberations. 

Instead, the 

leases standard will focus on the 

definition of a lease. 

If the lease definition is not met, 

the contract should be 

accounted for in accordance 

with other applicable standards, 

such as revenue recognition by 

lessors and property, plant and 

equipment or executory 

contract accounting by lessees. 

While the concept of in-substance purchase is not expected to be included in the 

revised ED, a similar accounting result occurs where there is a purchase option 

with a significant economic incentive to exercise or a purchase obligation. 

Further, the elimination of in-substance sales from the leases guidance will 

reduce some of the inconsistency between the leases and revenue recognition 

guidance. Lessors will be required to evaluate indicators of continuing 

involvement (e.g., put/call options, purchase obligations, and lessor guarantees) 

in accordance with the principles-based approach in the proposed revenue 

recognition guidance rather than the existing rules-based guidance to determine 

whether they are in the scope of the revenue or lessor accounting model. This 

may result in a significant change to the timing of when a lessor would recognize 

revenue. 

Lease 

incentives 

Not covered. 

Lessees will deduct all lease 

incentives from the initial 

measurement of the right-of-use 

asset. 

It is unclear whether the differentiation in the accounting that exists today 

between incentives that are provided for lessor improvements and incentives 

that are provided for lessee improvements will be carried forward under the 

revised ED. The revised ED is expected to provide detailed application guidance 

on how various lease incentives and other payments between the lessee and 

lessor that are not scheduled as "lease payments" should be accounted for. 



Leveraged 

lease 

(Lessor 

accounting in 

U.S.) 

Not covered. 

Leveraged lease accounting will 

be eliminated and a lessor will 

be required to apply the general 

lessor approach appropriate for 

the underlying asset. 

Since pre-existing leases will not be grandfathered, companies with leveraged 

leases could have significant balance sheet increases as the inherent secured 

borrowings and deferred taxes in leverage lease transactions presented net today 

would need to be presented on a gross basis. Further, significant transition 

adjustments to retained earnings may result as the expense recognition patterns 

will change. 

Non-lease 

elements (e.g., 

service 

elements and 

"executory 

costs" such as 

real estate 

taxes, 

insurance and 

utilities) 


should apply the 

proposed revenue 

standard to a distinct 

service component of 

a contract that 

contains both service 

and lease 

components. If the 

service component is 

not distinct, the 

FASB proposed that 

lease accounting 

should be applied to 

the combined 

contract. The IASB 

proposed that a 

lessee and a lessor 

applying the 

performance 

obligation approach 

should apply lease 

accounting to the 

combined contract, 

whereas a lessor 

applying the 

derecognition 

approach should 

account for the 

revenue component 

in accordance with 

the proposed revenue 

Lease and non-lease 

components in a multiple 

element contract should be 

identified and accounted for 

separately. 

The boards have implied that all lease and non-lease elements for real estate 

should be separated. This includes segregating from lease payments amounts 

relating to both services and items that today are considered "executory costs," 

such as real estate taxes, insurance, and utilities. 

Judgment may be required to allocate payments due under a lease contract 

between the various lease and non-lease components. For net leases or modified 

gross/base year leases, service elements are either separately billed (e.g., net 

lease) or readily obtainable in the lease contract (e.g., the base year portion of a 

modified gross lease). For gross leases, based upon the specific facts and 

circumstances, we would recommend a lessee seek to obtain the amounts being 

billed for services from the lessor or make estimates of these amounts using 

market-based information. 

Questions are likely to arise regarding the application of this allocation guidance 

when a multiple element contract provides for both fixed and variable payments. 

We believe that this evaluation will be facts and circumstances driven. The 

allocation of consideration between lease and non-lease components will 

become more important because of the requirement to always recognize assets 

and liabilities for the lease component of the contract. 



standard even where 

it is not distinct. 

Presentation – 

cash flow 

A lessee should 

classify cash 

payments for leases 

as financing activities 

in the statement of 

cash flows and 

present them 

separately from other 

financing cash flows. 

A lessor should 

classify cash receipts 

from lease payments 

as operating activities 

in the statement of 

cash flows 

Under the SLE approach, the 

lessee would classify cash paid 

for all lease payments as 

operating activities. 

Under the I&A approach, the 

lessee would classify cash paid 

for lease payments relating to 

the principal as financing 

activities, and classify or 

disclose cash paid for lease 

payments relating to interest in 

accordance with applicable 

GAAP on the statement of cash 

flows. Variable lease payments 

not included in the 

measurement of the liability to 

make lease payments and shortterm 

lease payments not 

included in the liability to make 

lease payments would be 

classified as operating activities. 

For lessees under the I&A approach, the statement of cash flows will become 

more complex than under current operating lease accounting because lease 

payments will be split between operating and financing cash flows. These 

changes in classification may require changes to certain compliance ratios 

included in lessees' bank covenant arrangements. However, the impact to both 

operating and financing cash flows will be lower than under the initial ED 

because of the change in classification of the interest element of lease payments. 

For lessees under the SLE approach and for lessors, the cash flow statement 

presentation is not expected to be significantly different than under existing 

practice. 

A lessor should classify the cash 

inflows from a lease as 

operating activities in the 

statement of cash flows. 

Presentation — 

Balance sheet 

for lessees 


present liabilities to 

make lease payments 

separately from other 

financial liabilities 

and present right-ofuse 

assets as if they 

were tangible assets 

For leases under the I&A 

approach and SLE approach: 

Lease assets and lease 

liabilities should be 

separately presented in the 

statement of financial 

position or notes to the 

Most lessees will present the right-of-use asset within property, plant, and 

equipment. However, for financial institutions, it is not clear how regulators will 

view the right-of-use asset for purposes of determining minimum regulatory 

capital requirements. If regulators view the right-of-use asset as an intangible, it 

may not be considered an asset included in the denominator of Tier One 

leverage ratios and would be subject to higher risk weighting for the risk-based 

capital ratios. 



within PP&E or 

investment property, 

as appropriate, but 

separately from 

assets that the lessee 

does not lease. 

financial statements. 

The right-of-use asset 

would be classified in a 

manner consistent with 

classification had the entity 

owned the underlying asset. 

For lessees, the changed profile of the balance sheet and related income 

statement effects could have implications for state and local tax apportionment 

as well as franchise and property taxes. Multi-national companies will also need 

to evaluate the impact of the changes in rules on their international tax profile. 

There will be no 

clarification of whether the 

right-of-use asset 

recognized by the lessee 

represents a tangible or 

intangible asset. 

Presentation – 

Balance sheet 

for lessors 

A lessor applying the 

derecognition 

approach should 

present rights to 

receive lease 

payments separately 

from other financial 

assets and should 

present residual 

assets separately 

within PP&E. 

Under the receivable and 

residual approach the lessor 

should either present the lease 

receivable and the residual 

asset: 

Separately in the balance 

sheet, summing to a total to 

be called "lease assets," or 

Together in a single line 

item—lease assets—in the 

balance sheet, and 

separately disclose those 

two amounts in the notes. 

The revised ED is not expected to require explanation of the underlying nature 

of the residual asset. The requirement to recognize accretion of the residual 

asset as interest income is consistent with a view that the residual asset is a 

financial asset. However, the presentation option and the requirement to apply a 

long-lived asset impairment, rather than financial asset impairment, model may 

imply that the residual asset should be viewed as non-financial. 

Presentation would remain 

consistent with current practice 

for leases not classified under 

the receivable and residual 

approach. 




Income 

statement for 

lessees 


recognize 

amortization of the 

right-of-use asset 

(straight-line), and 

interest on the 

liability to make lease 

payments (effective 

interest rate). The 

result is a front 

loading of expense in 

the income 

statement. 

Under the I&A approach, a 

lessee should recognize interest 

expense and amortization 

expense separately in the 

income statement. 

Under the SLE approach, a 

lessee should recognize lease 

expense as one amount in the 

income statement. 

Due to the variety of changes to the income statement (i.e., interest expense, 

amortization expense, etc.) lessees applying the I&A approach will need to 

assess the potential impact on covenants, compensation agreements, and other 

contracts. Such an assessment may require significant time. As such, we suggest 

companies begin the process well in advance of the effective date. 

The boards also 

proposed that the 

amounts be broken 

out on the face of the 

financial statements. 


Income 

statement for 

lessors 

Under the 

derecognition 

approach, a lessor 

should present in the 

income statement 

interest income from 

rights to receive lease 

payments separately 

from other interest 

income. 

Under the 

performance 

obligation approach, 

a lessor should 

present in the income 

statement interest 

income on a right to 

receive lease 

A lessor should present: 

The accretion of the 

residual asset as interest 

income, 

The amortization of initial 

direct costs as an offset to 

interest income, and 

Lease income and lease 

expense in the statement of 

comprehensive income 

either in separate line items 

(gross) or in a single line 

item (net), on the basis of 

which presentation best 

reflects the lessor’s business 

model. 

Similar to lessees, lessors will need to assess the impact on covenants, 

compensation agreements, and other contracts. Such an assessment may require 

significant time. As such, we suggest companies begin the process well in 

advance of the effective date. 

Presentation of lease income and lease expense gross or net may depend on the 

lessor's underlying business model. For example, a manufacturer and lessor of 

equipment may elect to apply the gross method and present significant lease 

revenue while a financial institution may elect to apply the net method. 



payments, lease 

income resulting 

from satisfaction of a 

lease liability, and 

depreciation expense 

on an underlying 

asset separately, 

totaling to a net lease 

income or net lease 

expense. 

Purchase 

options 

Options to purchase 

the underlying asset 

in a lease are 

excluded from the 

measurement of the 

liability and the 

asset. 

A lease contract 

should be considered 

terminated when an 

option to purchase 


is recognized. Thus a 

contract would be 

accounted for as a 

purchase and sale by 

the lessee and lessor, 

respectively, when 

the purchase option 

is exercised. 

Lessees and lessors should 

include the exercise price of a 

purchase option (including 

bargain purchase options) in the 

measurement of the lessee’s 

liability to make lease payments 

and the lessor’s right to receive 

lease payments, if the lessee has 

a significant economic incentive 

to exercise the purchase option. 

In other words, purchase 

options are accounted for in the 

same manner as the proposed 

accounting for lease extension 

options. If a lessee determines it 

has a significant economic 

incentive to exercise the 

purchase option, the right-ofuse 

asset would be amortized 

over the economic life of the 

underlying asset rather than 

over the lease term. (See 

discussion of "In-substance 

Purchase.") 

The revised ED aligns the accounting for purchase options with the accounting 

for renewal options. This reflects the consistency in the economics of the 

following two transactions where in substance the lessee has the right to use the 

leased asset for its entire economic life: 

Six year lease of equipment with a 10 year economic life. The initial lease has 

a four year renewal option. At lease commencement the lessee has a 

significant economic incentive to exercise the renewal option. 

Six year lease of equipment with a 10 year economic life. The initial lease has 

a purchase option that the lessee can exercise in year four. At lease 

commencement the lessee has a significant economic incentive to exercise 

the purchase option. 

For lessors of real estate this could be a significant change. This is because 

upfront revenue would be recognized when a purchase option exists in a lease 

arrangement, even though legal title to the leased property may never pass to 

the lessee. 



Purchase 

obligations 

An entity should not 

apply lease 

accounting to 

contracts that meet 

the criteria for 

classification as a 


underlying asset. A 

contract represents a 


underlying asset if, at 

the end of the 

contract, an entity 

transfers to another 

entity control of the 


asset and all but a 

trivial amount of the 

risks and benefits 

associated with the 


asset. An entity 

would meet this 

condition if it will 

transfer title to the 

underlying asset to 

the transferee at the 

end of the contract 

term or if the 

contract includes a 

bargain purchase 

option. The 

determination is 

made at inception 

and is not 

subsequently 

reassessed. 

Guidance on distinguishing 

between a lease of an 

underlying asset and the 


underlying asset is not 

provided. If an arrangement 

does not contain a lease, it 

should be accounted for in 

accordance with other 

applicable standards (e.g., 

property plant and equipment 

or revenue recognition). 

The existence of a lessee purchase obligation may affect whether a lessee should 

apply the I&A or SLE approach and whether a lessor should apply the receivable 

and residual or operating lease approach. 

If the lessee applies the I&A approach, the accounting is expected to be similar 

to that for a purchase of the underlying asset. Similarly, a lessor applying a 

receivable and residual approach would apply accounting that resembles a sale 

of the entire underlying asset (including any residual), even though legal title to 

the underlying asset does not transfer to the lessee until a later date. 



Reassessment 


should remeasure 

assets and liabilities 

arising under a lease 

when changes in 

facts and 

circumstances 

indicate there is a 

significant change in 

the liability to make 

payments or right to 

receive payments. 

A lessee and lessor should 

reassess the lease term only 

when there is a significant 

change in relevant factors such 

that the lessee would then either 

have, or no longer have, a 

significant economic incentive 

to exercise any options to 

extend or terminate the lease. 

Lease payments that depend on 

an index or a rate should be 

reassessed using the index or 

rate that exists at the end of 

each reporting period. 

The requirement to reassess these estimates entails significant incremental 

effort compared to the current model, under which lease accounting is set at 

inception and revisited only if there is a modification or extension of the lease. 

In addition, it may be necessary to invest in information systems that capture 

relevant information and support the reassessment of lease terms and payment 

estimates as facts and circumstances change. 

Residual value 

guarantee 

For lessees, the rightof-use 

model would 

require that the 

initial measurement 

of the obligation to 

pay rentals include 

residual value 

guarantees. 

Lessors would be 

required to recognize 

a receivable for 

residual value 

guarantees, but only 

if the receivable 

could be reliably 

measured. 

Lease payments should include 

amounts expected to be payable 

under residual value 

guarantees, except for those 

guarantees provided by an 

unrelated party. 

For lessees, amounts expected 

to be payable under residual 

value guarantees should be 

amortized consistently with how 

other lease payments included 

in the right-of-use asset are 

amortized. 

The amounts should be 

reassessed when events or 

circumstances indicate that 

there has been a significant 

change in the amounts expected 

to be payable under the residual 

value guarantee. 

The boards' redeliberation of the accounting for residual value guarantees 

occurred before the decision was reached that the lessee and lessor should apply 

a dual accounting model. As a result, there is currently no distinction in applying 

the guidance by lessees that use the SLE rather than I&A approach or by lessors 

that apply an operating lease, rather than receivable and residual, approach. 



A lessor will not recognize 

amounts expected to be received 

under a residual value 

guarantee until the end of the 

lease. The lessor will consider 

guarantees when determining 

whether the residual asset is 

impaired. 

Sale & 

leaseback 

transactions 

If the transfer meets 

the condition of a 

sale, the transferor 

accounts for the 

transaction as a sale 


the proposed revenue 

standard. When the 

conditions of a sale 

are not met, the 

contract is accounted 

for as a financing. A 

transferee will 

account for the 

transaction as a 

purchase if the 

conditions of a 

purchase are met. 

When not met the 

transferee will not 

recognize the 

transferred asset. The 

amounts recognized 

should be based on 

fair values with a 

gain or loss 

recognized. 

When a sale has occurred, 

pursuant to the revenue 

recognition guidance, the 

transaction would be accounted 

for as a sale and then a 

leaseback. Entities would apply 

the control criteria in the 

proposed revenue recognition 

standard to determine whether 

a sale has occurred. 

The boards' decision to align the sale criteria with the proposed revenue 

recognition standard would significantly change the proposal and may result in 

more transactions qualifying as a sale than under the initial ED and current 

GAAP. 

It may be appropriate to recognize upfront the full amount of the gain on sale. In 

longer duration leasebacks, some have argued that the seller/lessee retains a 

significant portion of the right-of-use asset and fundamentally only the residual 

asset was sold. In these cases, many believe only the portion of the gain relating 

to the sale of the residual asset should be recognized. There may be more 

discussion of sales & leasebacks and the interaction with the proposed revenue 

recognition standard when the revised ED is redeliberated. 

Seller/lessees that consummated a sale and leaseback transaction under existing 

U.S. GAAP that resulted in an operating lease are likely to pay particular 

attention to the proposed transition accounting. This is because any deferred 

gain on the original sale and leaseback will be reclassified into retained earnings 

at the transition date and will not provide the seller/lessee with any future 

income over the remaining term of the lease. 



Scope 

exclusions 


should apply the 

proposed guidance to 

all leases, except 

leases of intangible 

assets, leases of 

biological assets, and 

leases to explore for 

or use minerals. 

Entities that report 

under IFRS would 

also have an 

exemption for 

investment 

properties measured 

at fair value 

Includes contracts in which the 

right to use a specified asset 

(explicitly or implicitly 

identified) is conveyed, for a 

period of time, in exchange for 

consideration. 

Excludes: (1) leases to explore 

for, or use, minerals, oil, natural 

gas, and similar nonregenerative 

resources, (2) 

leases of biological assets, and 

(3) short-term leases. 

The FASB originally said it would provide an exemption for real estate measured 

at fair value pending completion of its Investment Property Entity project. 

However, in light of where the boards are with the dual model for lessors under 

the revised ED, this exclusion does not appear to be necessary. 

Short-term 

leases 

At the date of 

inception a lessee 

that has a short-term 

lease (12 months or 

less) may elect to 

ignore discounting 

when measuring the 

lease liability and 

asset. Lease 

payments would be 

recognized in the 


over the lease term. 

Lessees and lessors can elect to 

account for leases that have a 

maximum term of 12 months or 

less (including any renewal 

options) in a manner similar to 

today’s accounting for operating 

leases. 

This will reduce the burden of identifying and tracking short-term leases at each 

reporting period, and may alleviate the need to determine if certain short-term 

contracts include an embedded lease that requires payments to be split between 

the lease and the non-lease components of a contract. However, it also allows 

lessees and lessors to forego the election if they prefer to record on the balance 

sheet short-term lease commitments for asset classes that are deemed to be 

significant. 

This exception may result in a fundamental change in the structure of some 

contracts to meet the definition of "short-term" and allow lessees to avoid 

recognition of lease assets and lease liabilities. 

A lessor may elect 

not to recognize lease 


for short-term leases. 

Instead it would 

continue to recognize 





other guidance and 

recognize lease 

payments in the 


over the lease term. 

Subleases 

The accounting for 

subleases builds on 

the lessee and lessor 

accounting models 

that the boards have 

proposed. When a 

leased asset is 

subleased, the 

sublessor would 

account for the head 

lease (i.e., the lease 

agreement between 

the original lessor 

and the 

lessee/sublessor) in 

accordance with the 

proposed right-of-use 

lessee model. It 

would account for the 

sublease under the 

appropriate proposed 

approach for lessor 

accounting. 

Subleases would be accounted 

for as two separate transactions. 

That is, a sublessor would utilize 

lessee accounting on the head 

lease and lessor accounting on 

the sublease. 

We understand that there could be situations where the head lease and the 

sublease are accounted for under different models. For example, there may be a 

situation where a head lease is accounted for based on an I&A approach and the 

sublease is accounted for using an approach similar to existing operating lease 

accounting for lessors. Therefore, the sublessor could report lease expense on 

the head lease that is not completely offset by income on the sublease. 

Several questions may arise regarding how a sublessor would determine which 

lessor accounting approach to apply. Would the "consumption of the underlying 

asset" principle be applied to the actual asset being leased or just the portion of 

the asset that is leased by the sublessor? For example, how would a 9 year 

sublease be assessed that relates to a 1o year head lease for property with an 

economic life of 40 years? Would the sublessor consider the underlying asset to 

be the 10 year head lease or would the sublessor look to the 40 year economic 

life of the property? 

Some may have conceptual concerns over the accounting for a head lease and 

sublease. For example, the revised ED is likely to imply that a sublessor would 

initially recognize a right-of-use asset in relation to the head lease. However, if 

the sublease qualifies for the receivable and residual approach, it would appear 

that the entire right-of-use asset would be derecognized and replaced with a 

lease receivable and a residual asset. Application questions are likely to arise 

about how the lessee presentation and disclosure requirements should be 

applied to the head lease if the right-of-use asset is derecognized by the 

sublessor. 



Term option 

penalties 

Expected payments 

of term option 

penalties should be 

included in the 

measurement of 


arising from a lease 

using the expected 

outcome technique. 

The accounting for term option 

penalties should be consistent 

with the accounting for options 

to extend or terminate a lease. 

That is, if a lessee would be 

required to pay a penalty if it 

does not renew the lease and the 

renewal period has not been 

included in the lease term, that 

penalty should be included in 

recognized lease payments. 

Lessees should consider term options consistently between the lease term and 

lease liability. For example, if the term option penalty is minimal and the lease 

will not be extended, as there is no significant economic incentive, the lessee 

would not include the option in determining the lease term. However, the lessee 

would be required to include the term option penalty in the calculation of the 

lease liability. 


Authored by: 

Tom Wilkin 

Partner 

Phone: 1-973-236-4251 

Email: tom.wilkin@us.pwc.com 

David Humphreys 

Partner 

Phone: 1-973-236-4023 

Email: david.humphreys@us.pwc.com 

Krystyna Niemiec 

Senior Manager 

Phone: 1-973-236-5574 

Email: krystyna.m.niemiec@us.pwc.com 

Suzanne Stephani 

Director 

Phone: 1-973-236-4386 

Email: suzanne.stephani@us.pwc.com 

Datalines address current financial-reporting issues and are prepared by the National Professional Services Group of PwC. They are for general 

information purposes only, and should not be used as a substitute for consultation with professional advisors. To access additional content on 

financial reporting issues, register for CFOdirect Network (www.cfodirect.pwc.com), PwC’s online resource for financial executives. 

© 2012 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and 

may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details.

Dataline A look at current financial reporting issues - PwC

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