Lessor accounting presented particular problems for the IASB when developing the exposure draft (ED) on leases. Two quite different approaches to the treatment of the underlying asset were developed and each had its supporters, with no easy answer as to which was preferable. This contrasts with lessee accounting, where the basic approach is clear: the recognition of a liability for the commitment arising from a lease contract and a corresponding asset representing the right to use the underlying asset. Of course lessee accounting is not without its difficulties, but these essentially relate to the details of what to capitalise such as whether to include contingent rentals or optional lease periods and how to measure the related income statement expense items. However, for lessor accounting there is a more fundamental question of selecting the basic model itself.
IASB developed two alternative methods for lessor accounting: the derecognition approach and the performance obligation approach. In both methods, the lessor recognises a receivable for the right to receive lease payments from the lessee, which corresponds to the obligation (liability) recognised by the lessee. However, the two approaches deal rather differently with the remainder of the lessor’s interest in the underlying asset.
Over the full life of a leased asset, the net income recognised by a lessor must be the same irrespective of the accounting. However, the two approaches produce different balance sheet amounts through the life of the asset and a different pattern of income recognition.
Interested parties that IASB has consulted on lessor accounting have mixed views on the two approaches.
Here are three examples where the IASB posed the question of which approach was more appropriate.
Short term lease: assume that a company owns and operates a ship, but as the asset is temporarily surplus to requirements, it is leased to a third party for a period of one year. The derecognition model could lead to a profit being recognised on this deemed ‘partial disposal’ of the asset. The profit is based upon an assessment of the portion of the carrying amount to be derecognised, which is itself based upon comparing the fair value of the asset at the time of the deemed sale with the value of the lease receivable. The performance obligation approach would keep the carrying amount of the ship unchanged and not recognise any ‘disposal’ profit.
Uncertain lease term: assume that a lessor has acquired an asset and leased it to a lessee for a period that is a minority of the asset’s life but with an option for the lessee to extend the lease term, and that the lessor considers it likely that the lease term will be extended. In this case, under the derecognition approach, the amount derecognised would take account of the rentals expected to be received in the optional lease period and the profit on sale would accordingly include an amount that might not in fact materialise if the option to extend were not exercised by the lessee.
Equipment lease: assume that an airline leases aircraft from a bank (the lessor) to use in its operations. The lease terms are for 20 years. Under both approaches the bank would recognise an asset for the right to receive future lease payments. However, under the derecognition approach, the bank would no longer recognise the full cost of the aircraft as property, plant and equipment. In contrast, if the performance obligation approach is applied, the bank would not only recognise the asset for the right to receive future lease payments; the bank would also continue to recognise the full cost of the aircraft as property, plant and equipment.
The issue for investors is which approach to lessor accounting provides you with the most relevant information. Do you think that one approach for lessor accounting should be applied to all leases? (This would include for example, the three lease examples described above, all of which made the IASB pause for thought when developing the ED).
The model for lessor accounting that IASB describes in the exposure draft includes two approaches to accounting for the underlying asset. Under this model, certain leases, which may include the aircraft lease example above, are accounted for under the derecognition approach. For other leases, such as the short term lease and uncertain lease term examples above, the performance obligation model would be more appropriate. The determining factor given in the ED is whether the lessor retains exposure to significant risks or benefits related to the underlying asset. If this is the case, as it may be in the short term lease and uncertain lease term examples above, then the performance obligation approach would be used. However, the underlying notion is perhaps best described as one of differing business models.
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