Trueblood Case 09-4 Solution
How should NeedsSpace account for the two obligations noted as provisions in the lease agreement? ● Provision 1: “Lessor may require the lessee to perform general repairs and maintenance on the leased premises.” By entering the lease agreement, NeedsSpace (the lessee) becomes legally and contractually responsible for performing general repair and maintenance on the leased premises. Assuming that the lessee is required to make deposits to financially protect the lessor concerning the maintenance obligation by setting up a reserve, the guidance in ASC 840-10-05-9A through 840-10-05-9C states that the maintenance reserve shall be recognized as a deposit asset and reimbursed later when the required repair and maintenance is completed by the lessee. However, the provision in the lease agreement does not call upon the lessee to make deposits but simply requires the lessee to perform repair and maintenance on the leased premises. Alternative 1: Accrual Method
Since there is a contractual liability for the lessee to perform general repair and maintenance, the maintenance requirement provision may be assumed as a present economic obligation, not just a future commitment. If the fair value estimate of future maintenance expense can be measured with sufficient reliability, the provision may lead to recognition of an accrued liability for the repair and maintenance performance obligation at the inception of the lease. The accrued liability for the repair and maintenance can be reversed when payment is made or liability is created through the performance of the required repair and maintenance. Alternative 2: Direct expense method
Another way to treat this provision would be not to recognize at the inception of the lease but directly expense the costs when the required maintenance is performed. Regarding the accrual method in Alternative 1, ASC 360-15-25-5 prescribes that “the use of accrue-in-advance (accrual) method of accounting for planned maintenance activities is prohibited in annual and interim financial reporting periods.” This is consistent to FASB’s opinion shown in FSP AUG Air-1, which concludes that planned maintenance activities does not meet the definition of liability, and accrual method should not be used to account for those maintenance activities. FASB’s reasoning implies that accrual is not allowed as long as the definition of liability is met, even though the demand of maintenance is highly expected from the past experiences and the maintenance is planned accordingly. Although the AUG Air-1 allows the use of capitalization method and direct expensing method in the Airline industry practices, the maintenance requirement provision in the lease agreement above would be qualified for direct expensing treatment only, since “general” repair and maintenance would be expected to maintain the usability of the leased premises but not to increase their useful lives nor to provide other future benefits. Unless there is positive future benefit involved, repair and maintenance expense shall not be capitalized. Recommendation
The appropriate accounting treatment of the provision depends on whether it meets the definition of a liability. The maintenance requirement provision in the lease agreement simply asks for the performance of general repair and maintenance by the lessee. However, it still is uncertain whether the situation demands repair and maintenance would actually occur; and how much costs would be incurred. Based on these facts and circumstances, it seems that the provision does not meet the definition of a liability. According to the most recent Project Update of Conceptual Framework – Elements and Recognition (Phase B), a liability should be an “unconditional” economic obligation, but the repair and maintenance requirement by the provision may not be “unconditional” in that the required maintenance would be performed only when it’s needed. Consequently, Alternative 2...
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