Leasing: Is it a Good or a Service?
One of the important issues in revenue recognition is the question of whether a company is providing a good or service in return for the receipt of customer consideration. This is an important issue because the proposed revenue recognition model allocates customer consideration to the various performance obligations that arise in a contract with a costumer, and it is then the satisfaction of these performance obligations that gives rise to revenue recognition. If the performance obligation is to deliver a good, revenue recognition occurs at the point when control of the good has been transferred to the customer. If the performance obligation is to provide a service, revenue recognition will occur as the service is provided, which will be over time for multi-period service contracts.
The distinction between a good and a service may seem transparent, and often it is, but consider the case of leases. What is the appropriate way to view a lease? In leasing a car for 5 years, is a lessor providing a good (the car) or a service (5 years of access to the car)? If it is the former, then we might ask whether the lessor has any other performance obligations to satisfy once the car has been delivered to the customer. If not, revenue recognition could happen up front (except for the interest component of the financing arrangement). If it is the latter, then all of the revenue would be recognized ratably over the lease period.
Currently, the proposed lease model appears somewhat conflicted on the issue. On the one hand, the proposal is for the lessee to book an asset and an obligation at the start of any lease. In other words, we would say that the lessee has taken control of the asset at a point in time, and we book the asset received and the associated liability to make the remaining lease payments. But, on the flip side, the proposal is for the lessor (in the same transaction) to recognize revenue over the life of the lease, under the assumption that the lessor cannot transfer 5 years of access to an asset immediately. As a result, we wouldn’t have symmetry between how we treat the transfer of control for lessees and lessors.
What would be helpful in resolving this apparent inconsistency is a better understanding of whether we should treat leased assets as goods or services. What would also be helpful is clear guidance on when transfer of control takes place. What are the key indicators that the Boards should consider? What accounting treatments are most likely to be useful in various leasing circumstances? What treatments for leases are (in)consistent with the conceptual framework, and what disclosures are likely to be useful? These are just a few of the ideas I find myself wondering about.
Disclaimer: The views expressed here are my own and do not represent positions of the Financial Accounting Standards Board. Positions of the FASB are arrived at only after extensive due process and deliberations.