Dataline A look at current financial reporting issues - PwC

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.
PwC observation:
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:
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