Changes in ASC 842 Topic Lessee Application of Rate Implicit in the Lease – Is the Use of IBR Enough?


In previous post, we discussed how FASB is finalizing a change in ASC 842: Lease Accounting. As it stands, the change is set to impact every business that adopts GAAP to settle their books. FASB had been releasing updates every now and then to ensure that the new changes are well understood and implemented by the effective date. 

Although the implementation was due in 2019, due to some changes being considered by the FASB, this effective data has been delayed. On September 18, 2020, FASB came up with several updates to the standard and expressed them in two (virtual) roundtables, notes of which were also shared publicly. 

The updates were in regard to the challenges faced by organizations across the globe implementing ASC 842. FASB board members, industry group members, accounts preparers, users and others were present at the roundtable. 

One of the first topics to be discussed was the rate implicit by lessees in a lease.  

The Problem 

The principal amount of a lease is mentioned in contracts and in the books, but the interest rate itself isn’t explicitly mentioned anywhere. Instead, the lessee can determine the rate implicit with the help of present value factors, as required by ASC 842-20-30-3. 

This value needs to be mentioned if “readily determinable,” but if there are no present value factors available that can help determine the rate, lessees will have to mention the IBR (incremental borrowing rate). 

And therein lies the issue. The phrase “readily determinable” has become a major hurdle when it comes to the limitations on lessor-specific assumptions. These assumptions will usually be considered as factors that come in the way of allowing lessees to be able to determine the rate easily. Lessees usually don’t know every aspect of the agreement like lessors do.  

For example, a bank leasing equipment to a company would have a much clearer picture of the agreement compared to the company.  

Alternatives Proposed 

According to research conducted by FASB members, there were three potential alternatives to this: 

  1. No change to ASC 842 
  1. Eliminating the requirement for consideration of rate implicit 
  1. Providing a mode of rate implicit measurement to lessees in ASC 842  

Right now, lessees almost always use IBR in place of rate implicit unless the lessor specifically lets the lessee know the rate. Because of this, FASB made the following observations respectively. 

  1. The first alternative was the most preferred one out there, considering how it eliminated the need for implementation of new processes. By doing so, ASC 842 remains consistent with IFRS 16 
  1. A problem that arose was that since most lessees used the IBR by default, why was there any need for FASB to recommend the use of rate implicit in the first place? It would only cause more confusion. However, an argument was made that using this rate for lessees resulted in a symmetry in accounts, i.e., classification and measurement between lessor and lessee. However, it was determined that it wasn’t the board’s objective to achieve symmetry, but only consistency and clear representation.  
  1. The third alternative suggested the use of a uniform method of determination of the rate implicitIf implemented, it would increase the usage of this rate compared to before the change. While this would introduce a bit more complexity in lessee accounting, it would result in more consistent and comparable books. 

The Solution 

Although the third alternative offered uniformity, stakeholders agreed that the lessee application of rate implicit in the lease didn’t need any change. Account preparers and users mostly agreed that they didn’t struggle when it came to applying the phrase “readily determinable” in their books.  

Some did argue, however, that since there was no struggle with regards to ACS 842, it didn’t mean that there is no concern about the use of rate implicitSome agreed that alternative C would be best-suited for future lessee accounting and therefore, consistency.  

While this ASC 842 topic didn’t see any change, the FASB also considered other topics, such as Embedded LeasesLessee Application of Incremental Borrowing Rate and Lease Modifications. You can learn more about these topics in upcoming entries on our blog page, or if you’d like to get straight to its implementation, we recommend you try out iLeasePro, a fully automated lease accounting solution 

Get in touch with us today to schedule a free demo! 


ASC 842 Changes: Would a Specific Incremental Borrowing Rate Be Better?

image_pen The problem of determining the rate implicit in a lease also presented a concern that most preparers used the incremental borrowing rate (IBR) as the discount rate. However, that wasn’t the only concern that came to light during FASB’s roundtable in September 2020.   Apart from the rate implicit, members also discussed the IBR; i.e., how those that have adopted ASC 842 determine the IBR. It was recognized that a lot of time and effort goes into estimating the borrowing rate.  The Problem  For Non-Public Business Entity (Non-PBE) lessees, a risk-free rate is determined which uses a period set in the lease terms (paragraph 842-20-30-3). This risk-free rate was another cause for concern at the roundtable. The use of this risk-free rate under the current economic climate meant low rates and therefore high artificial lease liabilities, thus being potentially misleading for users.   When the costs incurred to determine the IBR, and the prospect of using a risk-free rate were combined, a question arose whether non-public business entities as well as public should be allowed to use some other rate or not.  Alternatives Proposed  Based on the argument, FASB proposed two alternatives to the members, preparers, and users in the roundtable handout. 
  1. No change. The rate and method used right now to determine and use IBR for PBE and non-PBEs should remain the same.  
  1. Both PBE and non-PBE lessees must use a market-specific rate instead of IBR.  
When the two alternatives were discussed, following were the respective arguments for and against the prospects.  
  1. Non-PBE would encounter issues when trying to determine IBR that falls on the definition presented in ASC 842 for IBR. The problem they would face would primarily be that they don’t have enough resources or departments that can determine a lease credit risk. However, if nothing is done, it is important to remember that the cost of determining IBR will only go down on a go-forward basis.  
  1. The second alternative suggested that a rate be recommended like in ASC 944 (Insurance) and ASC 715 (Compensation). The use of this rate would significantly simplify the whole process, not to mention result in more uniform and comparable books. The problem here is that the rate may be very different from risk-free rates that non-PBEs use. 
The Decision  Most participants agreed that the first alternative is much better, i.e., current requirements for IBR should remain the same for public companies. Preparers agreed that creating a new process for IBR would cost even more, though they agreed that postimplementation costs would be lesser.   Since users mostly use Disclosureto compare and evaluate companies, IBR didn’t really make much of a difference there.  However, this was all limited to PBEs. When it came to non-PBEs, most members were in favor of making adjustments to the standard. The change in ASC 842, if any, would be targeted toward allowing non-PBEs to choose whether they use the risk-free rate on: 
  • An asset-class basis  
  • Or for the whole entity. 
It was acknowledged there was a certain arbitration involved by allowing non-PBEs to use risk-free rates. To that end, members mostly were in favor of letting the FASB determine a specific rate for non-PBEs and implementing it via ASC 842.   Try iLeasePro for free right now; You can take a video tour of iLeasePro or schedule some time on our online demo calendar to see how iLeasePro can help you and your firm comply to the ASC 842 Standard.

Sage Intacct and iLeasePro Announce Major Integration Enhancement

iLease Management LLC (“iLease”), developer of iLeasePro, an enterprise cloud-based Lease Management and Accounting solution, has announced a major step forward in its strategic partnership and integration with Sage Intacct, a leader in cloud-based financial management and accounting software. iLease has released the capability to take advantage of Sage Intacct’s dimension feature to seamlessly track and report lease related financial and operational data.

The Sage Intacct dimension feature offers an entirely new way to track and report on financial and operational data, while simplifying the user’s chart of accounts. With dimensions, a user “tags” a transaction with certain designations such as department, location, etc., without the need to expand the chart of accounts. By adding this new feature, an iLeasePro user can tag any dimension to the general ledger accounts associated with the lease. Once tagged, the iLeasePro user can automatically generate the journal entries with the dimensions and via webservices, upload the journal entries into the Sage Intacct general ledger.

“We are excited that we have made a major step forward in our integration with Sage Intacct,” stated Sean Egan, Managing Partner iLease Management LLC. “It was clear in speaking with Sage Intacct users that the dimensions is such an important feature to their operating efficiency and reporting. Adding dimensions to iLeasePro only strengthens the seamless synchronization of key lease accounting data between the two solutions.”

“We are pleased iLeasePro continues to enhance their integration with Sage Intacct.   As the requirements for monitoring and tracking lease details expand, iLeasePro’s enabling the power of Sage Intacct Dimensions will improve reporting and insight for our mutual customers.“ Chris Rose, Vice President of Business Development at Sage Intacct.

Check out iLeasePro on the Sage Marketplace:

Proposed Lease Accounting Standard Changes – Key Business Considerations for Lessees

I have heard it said many times that accounting results should not drive the basic economic decisions related to business. And I generally agree with that point of view. But it is difficult to ignore completely the accounting results and business analytical metrics that result from changes in accounting treatment and certainly the changes in lease accounting currently being proposed by the Financial Accounting Standards Board (“FASB”) and the International Accounting Standards Board (“IASB”) will drive significantly different accounting results and metrics as compared to current accounting requirements. Therefore, let’s examine some of the business considerations that financial decision makers should take into account as they evaluate the impact of the proposed standard. As in the past, our focus will be on lessees since the proposed changes will have the greatest impact on their financial results. The issues will be considered separately for property and equipment leases but many of these issues will be relevant for both types of leases. Further, the impact will be much greater for those companies whose leases are currently categorized as operating leases, so we will limit our discussion to the effect of the change from current operating lease accounting versus the proposed standard. We will also consider how the proposed accounting standard might impact certain selected industries.

Before thinking that we are being premature in dealing with these issues given that the proposed standard might not be effective until 2017, remember that a five year lease that is being finalized currently might well have to be transitioned into the proposed new accounting model at the effective date. Financial decision makers should be prepared to understand, at least in general, the terms of the future accounting ramifications of decisions that are being made currently.   To read more, please download the whitepaper at Business-Considerations-for-the-FASB-IASB-Lease-Accounting-Changes

Lease Accounting Update January 2013: Lease Components in a Single Lease Contract

The FASB and the IASB (“The Boards”) met on January 30, 2013 to continue further deliberations on the Lease Accounting Project. The discussions were narrowly focused on the instances where multiple lease components are contained in a single lease contract. As examples, multiple pieces of equipment could be leased under a single lease contract, a single lease contract could contain both property and non-property components or land and building(s) could be leased under a single lease contract.  The central issue discussed revolves around whether individual lease components in a single lease contract must be accounted for separately. The Boards tentatively concluded that for components that are distinct from other goods and services in the lease contract and the components are not customized to meet the particular needs of the customer, those distinct components should be accounted for separately. A single lease that contains components (for example, property and non-property) that are customized and integrally related would be accounted for as a single lease contract. Land and building(s) contained in separate lease contract would be treated a single component and would not be allocated (a difference from current GAAP treatment).

For a lease contract that contains both property and non-property and must be accounted for as a single component, an additional issue deliberated was which lease classification test would apply in these circumstances. The Boards tentatively concluded that the lease classification of the primary (predominant) asset would determine the lease classification. Therefore, if the equipment was deemed to be the primary asset, the presumption would be that the accelerated amortization method would be used whereas if the property was deemed to be the primary asset, the straight-line method would be presumed to apply.

From the previous example, it is clear that any technology solution that a lessee chooses to employ to comply with the new lease accounting standard should be capable of tracking and accounting for both property and non-property (equipment) components. We at iLeasePro have anticipated this need and are developing our lease management and accounting technology product as an integrated solution for both property and equipment.

The Boards additionally indicated that they plan to issue a revised Exposure Draft (“ED”) by the end of March 2013 which will be open for comment for a period of time. Redeliberations and discussion of comments on the revised ED will begin in the second half of 2013.

Importance of Documentation and Compliance

We all know that documentation and compliance has become extremely important in our current business environment,i.e., clear and complete explanations as to why certain actions or changes have been made and the ability to identify the source of those changes. But sometimes it can be time consuming and difficult to provide the documentation and  identification of responsibility that is necessary, even when a technology product is being used. When we were designing iLeasePro, our technology solution for Lessees, we anticipated the need to address these issues and incorporated two user friendly features into our product that facilitate documentation and compliance.

The Notes feature allows the user to add a notation on any page within the application that can provide critical additional documentation and explanation. It is easy to use – just bring up the Note, insert your explanation and it is attached to that page and there for any user to reference.

The Change History feature identifies any addition, deletion or modification made to the original lease information input into the application. This feature stores and reports those changes, identifying the timing and the individual responsible for the entry thereby facilitating audit and management review.

Technology solutions must evolve and be designed to meet the current requirements of the marketplace. These are just two examples of how iLeasePro is meeting the demands of the marketplace.

Lease Accounting Update December 2012

There has not been much mention over the last few months about the FASB and IASB Boards (“the Boards”) Joint Project which would result in significant changes in the manner in which leases are accounted for. The Boards have instructed the staff to revise the Exposure Draft to incorporate the tentative conclusions that have been reached by the Boards. The revised Exposure Draft is expected to be issued in the first quarter of 2013. Interested parties should review the revised Exposure Draft carefully to evaluate the changes to the original document, however, we believe  that most of the controversial issues have been discussed and agreed to by the Boards. All leases, except short term leases, will have to be reflected on the balance sheet of lessees and amortized in one of two ways, depending primarily upon the nature of the underlying asset being leased. The key consideration for the amortization method to be used would involve whether the lessee acquires or consumes more than an insignificant portion of the leased asset over the lease term. The presumption is that leases of property would be classified as straight-line leases unless there is evidence that a major portion of the property is consumed by the lease. Conversely, leases of equipment would be presumed to have accelerated amortization unless there is evidence that only an insignificant portion of the leased equipment is consumed.

Due to lack of visibility about these proposed changes over the last few months, it is easy to overlook the significance of the changes and the potential impact that they will have on lessees’ financial statements. The Boards have not provided any guidance on the proposed effective date for these changes; we hope that the revised Exposure Draft will provide additional insight on this issue. But going forward, lessees should keep in mind that any lease that commences in 2013 and has more than a five year term will probably have to be reflected on the lessees’ balance sheet at the time of the adoption of the new accounting standard.

February 28-29 2012 Joint FASB/IASB Board Meeting Update

The FASB and the IASB Boards (“the Boards”) met at the end of last month to discuss the status of the 2010 Exposure Draft (“the Exposure Draft”) on changes to lease accounting. The majority of the discussion centered on the lessee accounting issue. As has been the case in past meetings, the Boards again reaffirmed their commitment to institute an accounting model requiring that the vast majority of lease liabilities be recognized on the balance sheet. The focus of the discussion in this meeting was on the manner in which lease related expense is recognized and the concerns raised by a number of constituents regarding the accelerated expense recognition pattern which is contained in the Exposure Draft.  Unfortunately the Boards did reach any final conclusions and requested that staff engage in further industry outreach. However, there was some consensus that constituent concerns should be addressed and certain alternatives were discussed.

One approach discussed would reintroduce the concept of operating versus finance type leases into the analysis. For those leases that have operating lease attributes, a new type of amortization model would be utilized that would result in a smoother expense recognition pattern and might approximate a straight-line amortization, depending upon variables such as free rent periods and step rents. For those leases that have finance type lease attributes, the amortization method contained in the Exposure Draft would be utilized.

A second approach discussed would introduce another new amortization model which would consider the consumption of the underlying asset during the term of the lease. This method would depend heavily on the fair value of the underlying asset and the estimated decrease in value of the asset during the term of the lease.  In those situations where the fair value of the leased asset did not decrease or deceased slightly, the amortization expense would be higher in later periods and therefore the total lease expense would be smoother. This could be the case for many real estate leases. In those situations where the fair value of the leased asset decreased significantly, the amortization expense would be more straight-line resulting in an accelerated expense pattern. This could be the case for many equipment leases.

Our View

In attempting to address constituent concerns regarding expense recognition, the Boards have suggested approaches which, in essence, would add complexity, subjectivity and additional cost to the amortization calculations. In some instances, such as fair value estimates, lessees simply would not have the information available to them to make the required calculations. We believe that the feedback that the staff will receive to these approaches will not be positive. The Boards are scheduled to address the issues again in their April meetings and we strongly suggest that interested parties monitor future developments. It seems clear that a revised exposure draft will not be issued until the third quarter of this year.

In a related development, a survey was recently issued by CFO Publishing LLC which gathered responses from 179 senior executives on their plans for dealing with the proposed changes in lease accounting.  The responses are consistent with previous posts that we have entered on our Blog. Concerns were expressed regarding the impact on key financial ratios, costs associated with complying with the new accounting standard and business issues related to lease terms and lease versus buy decisions. Two additional key points were made. First, up to 65% of the respondents expect that moderate or substantial changes will have to be made to financial and operating IT systems. And second, only 10% of the respondents believe that they are adequately prepared for the changes at this point. Although there are still issues to be addressed before finalization of the new standard as indicated above, it is critical that companies begin now to prepare for the new standard by making a comprehensive inventory of all leases and capturing critical lease data in a manner that will facilitate review of this information and completion of the required calculations. For the vast majority of companies, this is not the type of analysis that can be completed and maintained on a spreadsheet.  Begin now to assess your particular situation and the system enhancements that will be necessary to address the business and financial issues that will inevitably arise.

Watch for a Revised Exposure Draft

The revised Exposure Draft on Lease Accounting should be issued in the near future. All interested parties should be prepared to review it and react to the revisions as quickly as possible. The FASB and the IASB have continued to discuss some major changes from the original proposal. Balance sheet recognition of other than short term leases should remain in place but we will want to review changes to issues such as the pattern of expense recognition. Other especially important issues will involve the proposed implementation date and how existing leases will be transitioned into the new accounting model. This revised document should provide a reasonably final  roadmap to the new accounting model.

Update on July 2011 Lease Accounting Activities

In their July 2011 meetings, The FASB and the IASB (the Boards) decided to formally re-expose the proposed lease accounting standard for public comment. The timetable for final issuance will be pushed out even further into the future. The Boards’ goal is to finish final deliberations in the third quarter of 2011 with the issuance of a revised exposure draft shortly thereafter.  It is likely that the final standard would not be issued until the second half of 2012.

The Boards continue to reaffirm previous tentative decisions related to accounting for short-term leases, variable lease payments and subleases. The Boards also expanded the scope of disclosure requirements in the area of maturity analysis and expense component disclosures.

With respect to lessor accounting requirements, the Boards developed an approach for lessor accounting that is different from the approaches put forth in the original exposure draft. This new approach, called the “receivable and residual approach”, would require balance sheet presentation of the lessor’s right to receive lease payments and would allocate the carrying value of the leased asset between the portion related to the right of use asset and the portion retained by the lessor.

Our View

Although the time table for final issuance of a new accounting standard has been extended even further, the basic principles related to proposed lessee accounting continue to be reaffirmed, namely, a balance sheet approach with the need for significant upfront calculations, reassessment of original conclusions under certain circumstances and an acceleration of expense recognition as compared to current GAAP accounting. The delay in issuance is mainly due to the Boards’ position that the new standard deal with both lessee and lessor accounting and the reconsideration of lessor accounting as compared to the proposals in the original Exposure Draft. The model now proposed for lessor accounting will be significantly more complex than the current GAAP requirements.

Lessees should continue to follow the approach that we have outlined in the past by making certain that critical lease information has been collected and organized in a manner that will facilitate the analysis required not only to meet the new accounting standards but also to satisfy business needs of the enterprise. For even a relatively small portfolio of leases, an easy to use technology solution is essential.

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