Dataline A look at current financial reporting issues - PwC

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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. PwC observation: 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' National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 14
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. PwC observation: 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. PwC observation: 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). National Professional Services Group | CFOdirect Network – www.cfodirect.pwc.com Dataline 15
Page 1 and 2: Dataline A look at current financia
Page 3 and 4: .4 In June 2005, the Securities and
Page 5 and 6: .9 In early 2011, the boards began
Page 7 and 8: .14 Although the project proposes c
Page 9 and 10: Potential outcomes for lessees Star
Page 11 and 12: loss and cash flows. After much bac
Page 13: The revised dual lessor accounting
Page 17 and 18: PwC observation: Judgment will be r
Page 19 and 20: Time-charter contract: A time chart
Page 21 and 22: index or rate that was applicable f
Page 23 and 24: The path forward .61 The boards are
Page 25 and 26: Topic Initial ED Revised ED PwC obs

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