United States: On the Horizon - May 21, 2013

CURRENT PRACTICE ISSUE

Asset retirement obligations in leasing arrangements

Some leases impose requirements on a lessee to restore a facility to its original condition at the end of a lease or to uninstall and remove leasehold improvements. The accounting for those obligations varies on their exact nature. Sometimes the obligation is considered to be part of minimum lease payments and is accounted for under FASB Accounting Standards Codification® (ASC) 840, Leases. When the obligation is not considered part of minimum lease payments, it may be an asset retirement obligation under ASC 410-20, Asset Retirement and Environmental Obligations: Asset Retirement Obligations.

Obligations included in minimum lease payments under ASC 840

Generally, an asset retirement obligation to remove or restore an asset of the landlord could be a part of minimum lease payments accounted for under ASC 840. Like a residual value guarantee, the entire estimated amount is included within minimum lease payments without regard to the probability that the lessor will require removal when classifying the lease. The estimated removal costs are included in the determination of straight-line rent and therefore are accrued over the term of the operating lease. Estimated removal costs are included in the capital lease obligation for capital leases. The liability is derecognized when removal costs are incurred or if the lessor waives removal.

Example: CompanyCo agrees to lease a building and wishes to retain some of the existing leasehold improvements from a previous tenant. The lessor agrees but requires the lessee to remove the improvements on conclusion of the lease. The obligating event is the signing of the lease. The requirement to remove the improvements would be considered part of minimum lease payments.

Obligations that require creation of an asset retirement obligation under ASC 410-20

A lease provision that requires a lessee to restore a property to its original condition or remove any leasehold improvements installed and owned by the lessee would normally create an asset retirement obligation for the lessee that is accounted for under ASC 410-20. Asset retirement obligations within leases are often enforced at the discretion of the lessor. For asset retirement obligations under ASC 410, the probability of the lessor enforcing the obligation is a consideration when the lessee determines the amount to be recognized for leasehold improvements (see ASC 410-20-55-44 through 55-46 for an example of when the probability of enforcement is low).

Example: CompanyCo leases a building and modifies the site to its requirements, including features such as signs, installed equipment, and interior walls. The lease provides the lessor with the right to require that all leasehold improvements be removed and the site restored to its original condition at the end of the lease. In this case, the obligating event is construction or installation of the leasehold improvements. The amount recognized by the lessee for the leasehold improvements should include an asset retirement obligation. Measurement of the asset retirement obligation would take into consideration the probability that the lessor will require removal of the improvements.

FASB AND IASB RELEASE REVISED LEASES EXPOSURE DRAFT

On May 16, the FASB and IASB released their revised joint exposure draft, Leases. The proposed changes to the accounting for leases are meant to provide transparency within financial reporting on operations and risk exposure related to lease transactions.

The core principle in the proposed guidance is for both the lessee and the lessor to recognize an asset and obligation in the statement of financial position upon commencement of the lease. The lessee would recognize a "right-of-use" asset and a lease obligation measured at the present value of the minimum lease payments due under the lease. The lessor would recognize a receivable for the lease payments and an obligation to provide the underlying asset.

Upon commencement of a lease, both the lessee and the lessor would classify a lease as either a Type A or Type B lease. Generally, nonproperty (equipment) leases would be classified as Type A leases unless either of the following conditions is present:

  • The lease term is for an insignificant part of the total economic life of the underlying asset.
  • The present value of the lease payments is insignificant relative to the fair value of the underlying asset at the lease commencement date.

The current guidance in the exposure draft does not define "insignificant."

Real property would generally be classified as a Type B lease unless either of the following conditions applies:

  • The lease term is for the major part of the remaining economic life of the underlying asset.
  • The present value of the lease payments accounts for substantially all of the fair value of the underlying asset at the lease commencement date.

Reassessment of the classification after the commencement date would not be permitted.

For lessees, a Type A lease would require recognition of interest and amortization consistent with the view that a lease comprises a purchase and related financing. A lessee with a Type B lease would recognize a single lease expense by calculating the unwinding of the discount on the lease liability combined with the amortization of the right-of-use asset. This effectively results in the net lease cost recognized on a straight-line basis over the term of the lease.

For lessors, the Type A lease would be accounted for upon commencement by recognizing a lease receivable, a residual asset (the expected amount of the underlying asset at the end of the lease term), and any resulting profit or loss. After commencement of the lease, the lessor would recognize in profit or loss (a) interest income resulting from the unwinding of the discount on the lease receivable, (b) interest income resulting from the unwinding of the discount on the gross residual asset, and (c) variable lease payments not already in the lease receivable during the periods in which they were earned. Lessors would account for Type B leases similar to operating leases under current guidance.

When a lease contains both lease and nonlease elements, both lessors and lessees would be required to separately account for the lease and nonlease elements. Lessors would account for the nonlease elements consistent with the multiple-element guidance in ASC 605-25, Revenue Recognition: Multiple-Element Arrangements. Lessees would not include payments for nonlease elements as part of the right-of-use asset and lease obligation, but would need to disclose future payments in a maturity schedule in the notes to the financial statements.

An entity would have the option to make an accounting policy election to not apply the guidance to short-term leases. The proposed guidance defines short-term leases as "a lease that, at the commencement date, has a maximum possible term under the contract, including any options to extend, of 12 months or less. Any lease that contains a purchase option is not a short-term lease."

For both the lessee and the lessor, there would be a substantial increase in the disclosure requirements under the proposed guidance.

The comment period on the exposure draft ends on September 13.

For more information, refer to FASB in Focus, "Proposed Accounting Standards Update on Leases."

SEC

NASDAQ withdraws its proposal to require an internal audit function

On May 7, NASDAQ withdrew its proposed rule to require that listed companies have an internal audit function in order to adequately consider the comments received on the proposal. NASDAQ has stated that it intends to resubmit a revised proposal.

CorpFin updates Compliance and Disclosure Interpretations

The Compliance and Disclosure Interpretations (CDIs) reflect the views of the SEC staff. They are not rules, regulations, or statements of the Commission and have not been approved by the Commission. The interpretations are highly informal in nature and are intended as general guidance and should not be relied on as definitive.

The Division of Corporation Finance (CorpFin) recently updated the following Compliance and Disclosure Interpretations:

  • Securities Act Sections
  • Securities Act Rules
  • Securities Act Forms
  • Regulation S-K
  • Exchange Act Form 8-K
  • Oil and Gas Rules

These CDIs were updated to provide guidance on certain specific topics, including

  • When it is appropriate to file a resale registration statement for securities sold in a private equity line financing
  • Whether additional securities of the same class already registered may be added to an automatic shelf registration statement on Form S-3 by post-effective amendment
  • Whether a registrant may incorporate by reference into Form S-4 risk factors disclosed in its most recently filed Form 10-K in certain circumstances
  • Whether a Form 8-K, Item 2.06 (material impairment), is required if the timing of an impairment conclusion coincides with, but is not in connection with, the preparation, review, or audit of financial statements required in the next Exchange Act periodic report

EDGAR Filer Manual revised

The SEC recently issued a Final Rule, Adoption of Updated EDGAR Filer Manual, to announce its adoption of a revised version of the EDGAR Filer Manual.

The revisions are being made primarily to implement the new Form 13F online application and to support the U.S. GAAP 2013 XBRL Taxonomy.

COSO UPDATES INTERNAL CONTROL FRAMEWORK

The Committee of Sponsoring Organizations (COSO) of the Treadway Commission issued an updated Internal Control – Integrated Framework (2013 Framework). The 2013 Framework broadens and clarifies the application of internal control and its effectiveness, in consideration of changes to business and operating environments since the issuance of the initial framework. Although the 2013 Framework retains the five components of internal control (Control Environment, Risk Assessment, Control Activities, Information and Communication, and Monitoring Activities), it also now identifies 17 specific principles related to these components that are necessary to achieve effective internal control.

COSO also issued Illustrative Tools for Assessing Effectiveness of a System of Internal Control and the Internal Control over External Financial Reporting (ICEFR): A Compendium of Approaches and Examples. The compendium and illustrative tools are intended to assist users (particularly preparers of financial statements for external purposes) in assessing whether an internal control system meets the requirements of the updated 2013 Framework.

Users are encouraged to transition to the 2013 Framework as soon as feasible. The original 1992 Framework will be available through December 15, 2014, at which time it will be superseded and the updated Framework will be required. Further discussion can be found in Grant Thornton's May 15, 2013 Corporate Governor Alert.

COMMENT LETTER ISSUED

On May 15, the firm issued a comment letter in response to the FASB's proposed Accounting Standards Update (ASU), Recognition and Measurement of Financial Assets and Financial Liabilities.

The comment letter is available at grantthornton.com.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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