Rethinking The Right-Of-Use Asset

Author:Mr John Hepp and Mark Scoles
Profession:Grant Thornton LLP

The attempt to find a single lease accounting model based on recognition of a right-of-use asset has faltered. In this article, two professionals in Grant Thornton LLP's National Professional Standards Group suggest a control-based model as an alternative.

The FASB and IASB (the Boards) are preparing to issue a second exposure draft on lease accounting later this year or early next year. This exposure draft is expected to include a second lease accounting model in addition to the original model based on recognition of a right-of-use asset. The right-of-use asset itself isn't being rethought.

Some may attribute the addition of a second model to political pressure or resistance to change on the part of preparers. Others have noted a lack of consistency between the right-of-use asset model and the control-based model for revenue recognition, despite similarities in the economic substance of the transactions. We fall into the latter group.

Regardless of the reasons for the new exposure draft, we are concerned that the current models are complex, conceptually challenged, and unlikely to provide financial statement users with decision-useful information. In our view, the problems that the Boards are encountering in the lease accounting project are largely due to conceptual shortcomings inherent in the right-of-use asset.

The current state of affairs

Under existing GAAP, leasehold rights are considered to be executory contracts unless the lease transfers substantially all of the risks and rewards of ownership to the lessee. In a bold attempt to resolve issues with that model, the Boards issued a blanket assertion in their original discussion paper, Leases: Preliminary views, issued in March 2009.1 In a decision meant to clear the way for a single leasing model, the Boards decided that in a simple lease, the lessee obtains a right to use the leased item — a right that meets the definition of an asset. The Boards did not provide further clarification as to whether the right-of-use asset is considered to be a tangible or intangible asset.

Since then, the single lease accounting model based on the right-of-use asset has failed to gain general acceptance, in part because of concerns about measurement of the asset and obligation and, more recently, concerns about the income statements. A major concern of both lessors and lessees is that the accounting for rights of use would lead to earlier recognition of both revenue and expenses than would be the case under current operating lease accounting requirements.

In July 2012, the Boards decided to propose two models in a forthcoming exposure draft:

The interest and amortization (I&A) model, which is based on the right-of-use asset approach The single lease expense (SLE) model, which is designed to achieve straight-line recognition of rental expenses on the income statement Short-term leases and non-lease...

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