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Lease Contracts Will Have a Converged Definition in GAAP, IFRS

The FASB and IASB agreed to a definition of a lease contract that stresses the customer’s ability to use an asset and realize benefits from it. Before the final standard is written, the boards have to decide how much interpretive guidance it should have about applying the definition.

The FASB and IASB agreed on October 22, 2014, to broadly define a lease as “a contract that conveys the right to use an asset for a period of time in exchange for consideration.”

The definition means a customer must control the asset’s use and obtain “substantially all” its benefits. A customer has the right to direct the use of an asset whenever it has the right to direct how and for what purpose the asset’s used, including the right to change the use throughout the contract, the accounting boards said.

In addition, the boards decided that a supplier’s rights to the asset typically define the extent to which the customer can use it but don’t interfere with the customer’s right to determine how the asset’s used.

The discussion was part of the boards’ review of the converged proposals they issued in May 2013, as the FASB’s Proposed Accounting Standards Update (ASU) No. 2013-270, Leases (Topic 842), and the IASB’s Exposure Draft (ED) No. 2013-6, Leases.

The boards couldn’t decide after considerable debate if the final standard should have guidance about the circumstances that determine how the asset rights are transferred to the customer, although they want their research staffs to continue studying the issue and plan to debate it again at an upcoming meeting. The research staffs suggested that the standard could stipulate that a contract contains a lease only when the customer has the ability to derive the benefits from directing the use of the asset on its own or “together with other readily available resources.”

Board members said the question of resource availability risked creating opportunities for suppliers and customers to work around the proposed accounting standard and avoid putting assets on customers’ balance sheets by classifying them as service agreements through what the standard-setters call “structuring” a transaction.

Suppliers often specify that a customer use only their labor or products, and IASB member Gary Kabureck said the staff’s resource requirement might create a loophole for some lease customers.

“I think we’re cutting a real fine line to distinguish between one arrangement versus another arrangement, and I’m having difficulty with that,” said FASB member Lawrence Smith.

FASB Vice Chairman James Kroeker agreed with Smith but added, “Any line we draw is going to be fine, and we have to draw the line somewhere.” FASB Chairman Russell Golden said there would be very few circumstances when other resources weren’t available.

“We’re talking about unique assets,” Golden said.

Some IASB members nevertheless expressed strong opposition. Phillippe Danjou said the resource availability requirement would likely encourage companies to include restrictions in their contracts for the express purpose of having them qualify as service arrangements instead of leases.

“If I put restrictions in a contract, I can make the whole thing a service contract,” said Danjou. “I worry about the risk of structuring the contract to achieve that goal.”

FASB staffer Scott Muir reassured the boards that a lease contract with the supplier restrictions would violate the principle of control embodied in the revenue recognition standard the boards issued in May, although he conceded that the requirement would otherwise represent a “structuring bonanza.” Muir added that the language in the revenue recognition standard is something “everybody in the world is now adopting.”

Still, Kabureck had his doubts.

“It’s always bothersome to ignore something in a contract,” he said, as described “readily available” as “a very problematic phrase.”

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