asc topic 842 leasesthe fasb issued its new lease accounting standard on february 25, 2016 (asu...

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ASC Topic 842 – Leases

September 25 & 26 2017

2© 2016 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International

Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

Presenters/SpeakersDarin Kempke – Audit Partner & National Audit Energy Sector Leader

Michael Nesta – Power and Utilities (PU) Accounting Advisory Partner

Todd Fowler – PU Audit Partner

Landon Westerlund – Audit Partner at KPMG Department of Professional Practice (DPP) and Lease Implementation team

Brian Yurko – Audit Partner at DPP and Lease Implementation team

Scott Heiser – PU Audit Partner

Robert Wilson – PU Audit Senior Manager



Agenda Day 1

Introductions

Overview of ASC 842

Lessee Accounting

Lunch

Lessee Accounting

Lessor Accounting

Examples/Scenarios throughout



Agenda Day 2

Day 1 Re-Cap

Other Issues (i.e. Sub Leases)

Transition, Disclosures, Practical Expedients

Additional Examples

Wrap up



Background of Scenarios/Examples

Company A – Traditional Regulated T&D Electric Utility .

Company B – Traditional Regulated Natural Gas Utility

Company C – Subsidiary or separate company with owned Generation (both fossil fired & renewable)

NOTE: Examples and Scenarios throughout of PU related situations around the new lease

standard and will refer to the above Companies.

Overview of ASC 842


Cooperative (“KPMG International”), a Swiss entity. All rights reserved. NDPPS 536956

Where are we today? The FASB issued its

new lease accounting standard on February

25, 2016 (ASU 2016-02)

The IASB issued its new lease accounting standard on January 13, 2016 (IFRS 16).

The final standards are not converged.



Scope

Outside

scope

Scope with

exceptions

Within

scope

— Non-core assets

— Long-term leases of land

— Certain sales with repurchase

rights (supplier’s perspective)

— Short-term leases (lease term

≤ 12 months)

— Underlying assets of low value

(≤ $5,000, when new – IASB

only)

Leases of/to:

— Intangible assets

— Explore for or use

non-regenerative resources

— Biological assets

— Inventory

— Assets under construction

— The scope of the new leases

standard is substantially

aligned with current U.S.

GAAP.

Comparison to current

U.S. GAAP



Exemptions and practical expedientsShort-term leases

(lessees only)

— Leases with a lease term

≤ 12 months and do not

include an option to

purchase the underlying

asset that the lessee is

reasonably certain to

exercise may apply

current operating lease

accounting

— If elected, the exemption

is applied to all leases

within that class of

underlying asset

— Still subject to qualitative

and quantitative

disclosures

Underlying assets of low

value (IASB only)

— Exemption for leases of

underlying assets that are

individually low in value

(e.g., ≤ $5,000, when new)

even if material in

aggregate

— Leases would be

accounted for off-balance

sheet under IFRS, but

on-balance sheet under

U.S. GAAP (if not

short-term)

Portfolio approach

— Aspects of the new

standard may be applied

at a portfolio level

(e.g., determination of

discount rate and lease

term)

— Must be a reasonable

expectation that the

portfolio approach is not

materially different than

application to individual

leases

Lease definition, components, and key definitions/concepts



OverviewLease definition

Converged

FASB/IASB

definition

Identified assetControl over the use of

the identified assetLease

Asset is explicitly or

implicitly specified in the

contract

Asset is physically

distinct or customer has

rights to substantially all

of the asset’s capacity

Supplier does not have a

substantive substitution

right

Customer has right to

obtain substantially all

economic benefits from

use of the asset

Customer can direct the

use of the asset

Definition of a lease: A contract that

conveys the right to use an asset for a

period of time in exchange for

consideration



No1

STOP – Contract does

not contain a lease (apply

other GAAP)

Is the asset specified in

the contract (explicitly or

implicitly)?

Is the asset physically

distinct or does the

customer have the right to

receive substantially all

the capacity of the asset

Does the supplier have

substitution rights?

Are alternative assets readily

available/sourced by the supplier

within a reasonable period of time?

There is an identified

asset

Can the customer prevent

the supplier from

substituting the asset?

Supplier does not have a substantive

substitution right. Contract depends

on an identified asset.

STOP – Supplier has a

substantive substitution

right. Contract does not

contain a lease.

Yes

Yes

Yes

No

No Yes

No

No

Would the supplier benefit

economically from its right

of substitution?

1 Or it is impractical for the customer

to make this determination

No YesYes

Identified AssetLease definition



Supplier substitution rights

Can the customer prevent the

supplier from substituting the

asset?

Are alternative assets readily

available, or could be

sourced by the supplier within

a reasonable period of time?

Would the supplier benefit

economically from exercising

its substitution right?

Supplier does not have a

substantive substitution right.

Contract depends on an

identified asset.

Supplier has a substantive

substitution right. Contract

does not contain a lease.

No

Yes No1 No1

YesYes

1 Or it is impractical for the

customer to make that

determination.

Evaluation is based on facts and circumstances at contract inception. Evaluation excludes consideration of

future events, that at inception of the contract, are not likely to occur.

New consideration vs. current GAAP



Step 1

Step 3

Step 2

Step 4

Determine the scope of the customer’s right of use within the contract

Identify the economic benefits from use of the identified asset

Does the customer have the right to obtain substantially all of the

economic benefits from use of the identified asset?

Does the customer have the right to direct the use of the asset?

Yes

Yes

Contract is or contains a lease

STOP –

Contract does

not contain a

lease. Apply

other GAAP

No

No

Control over use of the identified assetLease definition



Include

By-products arising from use

of the underlying asset. For

example:

— Renewable energy credits

— Steam produced from

manufacturing

Exclude

Benefits derived from

ownership of the asset. For

example:

— Benefits related to tax

attributes

Economic benefits include:

— Direct benefits (from using, holding, or subleasing the underlying asset)

— Other economic benefits relating to the use of the underlying asset.

IMPORTANT: Capacity (e.g. to produce widgets or power, storage

capacity) is not necessarily the entirety of the economic benefits that

can be derived from use of an asset.

Economic benefits from use of the underlying assetLease definition



Rights in the contract

Example rights to direct how and for what purpose

asset is used throughout the period of useOther rights

Right to change type of

output produced

~WHAT~

Supplier

protective

rights

(1) See next slide for when rights are predetermined

Right to change when

output is produced

~WHEN~

Right to change where

output is produced

~WHERE~

Right to change whether

output is produced and, if

so, quantity produced

~WHETHER & HOW

MUCH~

Maintaining

the asset

Insuring the

asset

Operating

the asset (1)

Rights to direct the use of the underlying assetLease definition



Customer

Contract is or contains

a lease1

Who has the right to direct how and for what purpose the asset is used?

Predetermined Supplier

(1) See next slide

Contract may contain

lease1

Contract does not

contain a lease

Who has the right to direct the use?Lease definition



When to apply ‘predetermined rights’ guidance

Contract 1

Do not apply ‘predetermined rights’ guidance when only

SOME of the relevant decisions are predetermined

Relevant how and for what purpose decisions that are

predetermined:

Where What

Relevant how and for what purpose decisions

available to be made during the period of use:

When How MuchWhether

Contract 2

Apply ‘predetermined rights’ guidance

Relevant how and for what purpose decisions that are

predetermined:

Where What

Relevant how and for what purpose decisions

available to be made during the period of use:

None

When How Much Whether



Lease identification – Contract for a truckExample

Key Facts

▪ Customer enters into a contract with Supplier for

the use of a truck for 4 years.

▪ The contract specifies the truck and Supplier does

not have substitution rights.

▪ The contract includes restrictions on where the

truck can travel (only in the U.S.), how far it can

travel (not to exceed 120,000 miles), and restricts

the size of trailers that may be towed.

▪ Subject to restrictions, Customer still has

substantive rights to determine when, whether,

and where the truck goes, what the truck is used

for (e.g., what cargo it transports), and how much

output it produces (e.g., how much cargo it

transports).

Contract for a truck

Relevant decision-making rights available to be made during the

period of use:

Where What

Relevant decision-making rights that are partially predetermined

(restricted):

When

Whether How Much

Contract contains a lease

Customer has the right to direct ‘how and for what purpose’ the asset

is used

Substantive decisions about how and for what purpose the asset is

used are not predetermined

What How MuchWhere



Lease identification – Specialized production facilityExample

Key Facts

▪ Customer enters into a contract with Supplier to

purchase all of the widgets produced by a

specialized facility for 12 years.

▪ The contract specifies the facility and Supplier

does not have substitution rights. The widgets

cannot be provided by Supplier from another

asset.

▪ Customer cannot change the output of the

facility – i.e., the facility can only produce the

specialized widgets it was designed to produce;

but Customer decides when (and whether) the

facility produces and how many widgets – i.e.,

how much output – it produces. That is,

Customer controls the relevant “how and for

what purpose” (HAFWP) decisions that are

available to be made during the period of use

▪ Supplier operates and maintains the facility.

Contract for specialized facility

Relevant HAFWP rights available to be made during the period of

use:

Whether How Much

Relevant decision-making rights that are predetermined:

When



is used because it controls the relevant, available HAFWP decisions



WhereWhat



Lease identification – Contract for a shipExample

Key Facts

▪ Customer enters into a contract with Supplier for

the use of a ship for 4 years.

▪ The contract specifies the vessel and Supplier

does not have substitution rights.

▪ The contract includes restrictions on where the

ship can travel (e.g., not permitted to travel off the

coast of Somalia), restricts certain types of cargo

(e.g. explosives, hazardous materials), and

requires Customer to put the ship into port at

predetermined intervals for maintenance.

▪ Supplier operates and maintains the ship

▪ Subject to restrictions, Customer still has

substantive rights to determine when, whether,

and where the ship goes, and what/how much

output it produces (i.e., what it transports and how

much)

Contract for a ship

Relevant decision-making rights available to be made during the

period of use:

Where What

Relevant decision-making rights that are partially predetermined

(restricted):

When

Whether How Much



is used



What WhenWhere



Decisions about how and for what purpose the asset is

used are predetermined

Customer has right to operate asset (or direct others to

operate asset) without supplier having right to change

operating instructions throughout period of use

Customer designed asset (or aspects of asset) in a

way that predetermines how and for what purpose the

asset will be used throughout period of use

Contract

contains a

lease

Yes

Yes

No

No

Contract does not contain a lease

Predetermined rightsLease definition



Customer A Supplier B

5-year agreement to store products in a

warehouse.

Supplier B is required to store the

products in a specified warehouse:

— Customer A has exclusive use of the

warehouse.

— Supplier B has no substitution

rights.

Is there a lease?

Example – Lease definition (1 of 2)Lease definition



Supplier B is required to store the products in a

specified warehouse:

— Supplier B has no substitution rights.

— Customer A has exclusive use of the warehouse.

— Customer A has the right to decide (and change)

what products it stores in the warehouse during

the 5-year term.

— Supplier B has the right to approve any change

in use of the warehouse for purposes other than

storage.

In addition, assume:

Identified

Asset

Control

over

Use?

Lease

As per the previous slide:

Example – Lease definition (2 of 2)Lease definition



Definitional implementation issues*Lease definition

Options

controlled by a

third-party

― While all optional periods to renew (or not to

terminate) a lease controlled by the lessor are

included in the lease term, those controlled by an

unrelated third party (e.g. a sublessee) are not

automatically included in the lease term (subject to

‘reasonably certain’ considerations).

Market rent ― Market rent is an index; therefore, any lease

payments based on ‘market rent’ are variable lease

payments that depend on an index or rate and should

be included in the measurement of the lease based

on the market rental rate at lease commencement.

Non-cash

consideration

― Non-cash consideration given by the lessee to the

lessor for the right to use an identified asset not

explicitly excluded from the ‘lease payments’ by Topic

842 (e.g. lessee guarantee of lessor’s debt) is

included in the lease payments.

* Examples, not all-inclusive! Entities should continue to monitor

additional developments, including from FASB and SEC.



Separating components of a contractStep 1

Step 3

Step 2

Step 4

Identify the separate lease components. In many cases there will be a

single lease component, but in some cases there will be multiple lease

components.

Identify any non-lease components – e.g., a maintenance or operating

services

Measure the ‘consideration in the contract’. This calculation is different

for the lessee versus the lessor.

Separate and allocate the consideration in the contract between the

lease and non-lease components. This process differs slightly for the

lessee and lessor, but in both cases requires the entity to maximize the

use of observable data.



Step 1: Identify the separate lease componentsSeparating components of a contract

A right to use an underlying asset (i.e., a lease), or a bundle of leases, is a

separate lease component if both of the following criteria are met:

— The lessee can benefit from the lease (or bundle of leases) on its own or

together with other resources that are readily available to the lessee, and

— The lease (or bundle of leases) is neither highly dependent on, nor highly

interrelated with, the other ROUs in the contract.

Separately account for land elements (even if above criteria are not met)

unless accounting effect of doing so would be insignificant



Step 1 – Identify the separate lease components

Separate lease

component

Separate lease

componentSeparate lease component

Separate lease

component

Contract 1

Lease of

asset A

Lease of

asset B

Contract 2

Lease of asset C Lease of asset D Lease of asset E

Separately account for land elements (even if above criteria are not met) unless accounting effect of

doing so is insignificant



Step 2: Identify any non-lease componentsContract

Lease components Non-lease components (1) Not a component

Allocate consideration in the contract (Step 4)

Activities (or lessor

costs) that do not

transfer a good or

service to the lessee (2)

Separating components of a contract



Step 2 – Identify any non-lease components

— Components of a contract = only items or activities that transfer a good or service to

the lessee

Example non-lease components Not a component

Providing utilities (e.g., water or electricity) to the lessee Delivering the leased asset

Common area maintenance Reimbursement of lessor costs for property taxes or

insurance

Equipment maintenance Residual value guarantees



Step 3: Measure the consideration in the contract (lessee)

Payments relating to use of the underlying asset1

Other fixed or in-substance fixed payments

Other variable payments that depend on an index or rate2

Incentives paid or payable to the lessee3

Consideration in the contract (lessee)

1 See paragraph 842-10-30-52 The payments are calculated using the commencement date index or rate3 Other than those include in paragraph 842-10-30-5




Step 3: Measure the consideration in the contract (lessor)

Consideration in the contract (lessee)

Are there any other variable payments that specifically relate to either:

The lessor’s efforts to transfer one

or more goods or services that are

not leases?

An outcome from transferring one


not leases?

ORNo

adjustment

necessary

No

Pa

rt 1

Apply variable consideration requirements in Topic 606 to measure the

amount to be included in the consideration in the contract:

YesYes

Step 1: Estimate the amount using

the expected value or most likely

amount

Step 2: Determine the portion (if

any) of that amount for which it is

probable that a significant revenue

reversal will not subsequently occur

Pa

rt 2

Consideration in the contract (lessor)




Step 4: Separate and allocate consideration between lease and non-lease components

Lessee Lessor

When there is an

observable standalone

price for each

component:

Unless the practical

expedient** is elected,

separate and allocate

based on the relative

standalone price of

components.

Always separate lease and

non-lease components.

Allocate consideration

following the Topic 606

transaction price allocation

guidance – i.e., generally

on a relative standalone

selling price basis.When there is not an

observable stand-alone

price for some or all

components:

Estimate the standalone

price, maximizing the use

of observable information.

Remember:

Activities (or costs of the lessor) that do not transfer a

good or service to the lessee are not components of

the contract. Therefore, no consideration is allocated to

such items.

** As a practical expedient, a lessee may elect not to separate the non-lease components of a contract from the lease component to

which they relate.




Example – Separating components of a contract (1 of 2)

Customer A enters into a lease with Supplier B for a warehouse for 5 years. Initial

annual payments of $100,000 increase by $5,000 per year. Of the annual fixed

payment, approximately $11,000 is intended to reimburse lessor’s costs of

property taxes and building insurance.

Right to use warehouse for 5 years

Total consideration of $550,000

How much of the consideration in the contract is allocated to the lease

component?

(continues on next slide)

Lessee A Lessor B




Example – Separating components of a contract (2 of 2)

How much of the $550,000 total consideration in the contract is allocated to the

lease component?

A. $500K (the initial fixed payment of $100,000 x 5 years).

B. $550K (the initial fixed payment of $100,000 increased by $5,000 starting from

year 2, i.e. the total fixed payment due under the contract).

C. $495K (the initial fixed payment of $100,000 increased by $5,000 starting from

year 2, reduced by the estimated amount attributable to the lessor’s property

taxes and building insurance of $55,000 for 5 years).

D. $605K (the initial fixed payment of $100,000 increased by $5,000 starting from

year 2 plus the estimated amount of the lessor’s property taxes and building

insurance of $55,000 for 5 years).




Determine and allocate the consideration in the contract

▪ Lessee and Lessor enter into a 3-year lease of equipment that includes maintenance

services of the equipment throughout the lease term.

▪ Lessee will pay Lessor:

Example

Scenario 1

— A fixed payment of $110,000 per

year,

— A variable payment of $7,700

each year the equipment is

operational for a minimum number

of hours at a specified level of

productivity.

Variable payments not solely related

to performance of maintenance

services – quality and condition of the

equipment affect its performance

Scenario 2


year,





productivity.

Variable payments relate specifically

to Lessor’s performance of the

maintenance services – equipment is

tried and tested; maintenance

services are specialized and critical to

any entity’s use of the equipment

Scenario 3


year,





productivity.

Same conclusion as Scenario 2



Determine and allocate the consideration in the contract (continued)

— Lessee evaluation:

Example

Scenario 1

— Fixed payment: $110,000 per

year,

— Variable payment: $7,700 per

year.

Scenario 2


year,


year.

Scenario 3


year,


year.

For all scenarios, Lessee does not include variable payments in the consideration in the contract

Consideration in the contract is:

$330,000 ($110,000 × 3) $308,100 ($102,700 × 3)

Component Stand-alone price Allocation scenarios 1 & 2 Allocation scenario 3

Equipment lease $315,000 $292,817 $273,385

Maintenance 40,000 37,183 34,715

$355,000 $330,000 $308,100



Lease termLease term comprises…

Non-cancellable period

Periods for which

lessee has option to

extend (or not

terminate)

Periods for which lessor

has option to extend (or

not terminate)

Includes any rent-free

periods

Include if lessee is

‘reasonably certain’ to

extend/not terminate

Include

— Determination of lease term remains substantially unchanged from current U.S.

GAAP.

Comparison to current U.S. GAAP



Reasonably certain— Reasonably certain is a high threshold of probability that must be met to

include optional lessee payments in the measurement of lease assets and

lease liabilities.

— Lessee must have a compelling economic reason to exercise the renewal or

purchase option (or not to exercise a termination option).

— Consider all economic factors relevant to the assessment.

Contract-

based factors

Entity-based

factors

Asset-based

factors

Market-based

factors



Example – Lease termOther information with respect to the lease of the warehouse is as follows:

At lease commencement, it is not reasonably certain Lessee A will exercise the 5-

year renewal option:

— Lessee considers relevant economic factors in reaching that conclusion,

including, but not limited to:

▪ Market rental payments for renewal period are at fair value

▪ The warehouse is not customized for Lessee A’s needs

▪ Lessee A has not committed to install leasehold improvements that will

have significant economic value after the non-cancellable period.

Non-cancellable period of the lease 5 years

Optional renewal period (rent approximates fair value) 5 years

Remaining economic life of warehouse 30 years

What is the lease term?



Lease paymentsPresent value (PV) of future lease payments over the lease term – Includes:

Fixed payments1 Purchase options3 Variable lease

payments (VLPs)5

Termination penalties2 Residual value

guarantees (RVGs)4

Special-purpose entity

structuring payments6

1. Fixed payments include in-substance fixed payments, less lease incentives paid or payable to the lessee

2. Only include the termination penalty if the lease term reflects the lessee exercising an option to terminate the lease

3. Include the exercise price of a purchase option if lessee is reasonably certain to exercise it

4. For RVGs lessee includes the amount probable of being owed

5. Include VLPs based on an index or rate (e.g., CPI) using the index/rate at lease commencement; and if in-substance

fixed

6. Payments include those made by the lessee to owners of a special-purpose entity for structuring the transaction

7. A lessor is required to use the rate implicit in the lease. A lessee uses its incremental borrowing rate if the lessor’s

implicit rate is not readily determinable.

8. Nonpublic business entities may make an accounting policy election to use a risk-free discount rate (FASB only)

Discount rate7, 8



Initial direct costs— Incremental costs of a lease that would not have been incurred if the lease had

not been obtained (i.e., not been executed)

Include

Commissions

Exclude

Legal fees

Payments made to existing tenant

to incentivize that tenant to

terminate the lease

Cost of evaluating the prospective

lessee’s financial condition

Cost of negotiating lease terms

and conditions

General overheads

Lessee Accounting



Example – Storage warehouse leaseLessee accounting

Lessee A Lessor B

— 5-year non-cancellable lease of a storage warehouse, with one 5-year renewal

option Lessee A is not reasonably certain to exercise at lease commencement.

— Annual payments (in advance) of $100,000 that increase by $5,000 per year.

— Annual payments during the renewal period are $125,000 (in advance),

increasing by $5,000 per year.

— Lessor B provides Lessee A with a moving allowance (i.e., a lease incentive) of

$15,000 which Lessor B pays to Lessee A at lease commencement in cash.



Ownership transfers at end of the lease term?

Lessee purchase option reasonably certain of exercise?

Finance

lease

Operating lease

Lease term = major part (e.g., 75%) of remaining economic life1, 2?

No

No

No

Yes

Yes

Yes

PV of 1) lease payments + 2) lessee RVG ≥ substantially all (e.g.,

90%) FV1?

Specialized asset with no alternative use to lessor?

No

NoYes

Yes

2 If the commencement date is at or near the end of the underlying asset’s economic life, this test does not apply

— Assessment criteria

are similar to current

U.S. GAAP, but

without explicit

bright lines

1 Comparison to current

U.S. GAAP

Lease classification testLessee accounting – lease classification



Thresholds for lease classification testsLessee accounting – lease classification

— Paragraph 842-10-55-2 permits (but does not require) use of “bright-line” thresholds

when performing the lease term and present value tests:

— May be appropriate to conclude that for some assets < 75% = major part of its

remaining economic life if the asset is of a type that degrades in economic utility in a

significantly front-loaded manner, while for others > 75% ≠ major part of its remaining

economic life if asset holds its economic utility or value.

— Because substantially all is used elsewhere in U.S. GAAP and generally considered

similarly, may not be substantial flexibility around that threshold.

— Generally do not think there is flexibility around 25% at or near the end threshold

because it relates to an exception to the classification principle

Threshold Permitted ‘Bright Line’

Major part of the remaining economic life ≥ 75% = major part

Substantially all of the fair value of the

underlying asset

≥ 90% = major part

At or near the end of the economic life of

the asset

≤ 25% of the total economic life

remaining = at or near the end



Alternative use test – New to Topic 842Lessee accounting - lease classification

— Consider:

— Underlying asset being of a highly specialized nature or subject to highly

specialized circumstances is key to meeting this test.

▪ Alternative use test not met solely because of contractual restrictions.

▪ Not another ‘lease term’ test

— When considering alternative use, consider the characteristics of the asset

that will ultimately be returned to the lessor at the end of the lease term (i.e.,

customizations or modifications agreed on or committed to at lease

commencement).

Contractual

restrictions

Practical

limitations



Example – Lease classification testOwnership transfers at end of the lease term?


Finance

lease

Operating lease

Lease term = major part (e.g., 75%) of remaining economic life?

No

No

No

Yes

Yes

Yes

PV of 1) lease payments + 2) lessee RVG ≥ substantially all (e.g.,

90%) FV?


No

NoYes

Yes

Lessee accounting – lease classification

Assumptions used:

— Rate implicit in the

lease not readily

determinable. Lessee

A uses its incremental

borrowing rate (which

is 6%).

— FV warehouse:

$1,500,000

— PV lease payments:

$488,564

— Remaining economic

life: 30 years



RecognitionLessee accounting

Lessor Lessee

Right to use

underlying

asset

Lease payments

ROU asset

Right to use

underlying asset

during lease term

Lease liability

Obligation to make

future lease

payments

— For lessees, all leases (other than

short-term leases) will be recognized

on the balance sheet

— Presentation of interest expense in

the income statement depends on

lease classification


Lessee A has the right

to use the warehouse

for 5 years

Lessee A has an

obligation to make the 4

remaining, unpaid

annual lease payments



Initial measurement – Lease liability Lessee accounting

Lease liabilityPresent value of unpaid

lease payments

A lessee initially measures a lease

liability (and a right-of-use asset) at the

lease commencement date. That is,

the date on which the lessor makes the

underlying asset available for use by

the lessee.

— Under current U.S. GAAP, the date

a company performs its lease

classification test and initially

measures a capital lease is at lease

inception (i.e., the date an

agreement is reached).




Example - Initial measurement – Lease liability Lessee accounting

— The rate implicit in the warehouse lease is not readily determinable.

Accordingly, Lessee A uses its incremental borrowing rate (which is 6%).

— There are 5 annual payments (in advance) of $100,000 that increase by $5,000

each year

▪ The 1st lease payment ($100,000) is made at lease commencement and

therefore is excluded from the measurement of the lease liability.

Lease liability

$388,564

PV of unpaid

lease payments

Payment Date Amount

Beg. of Year 2 $ 105,000

Beg. of Year 3 $ 110,000

Beg. of Year 4 $ 115,000

Beg. of Year 5 $ 120,000



Initial measurement – ROU assetLessee accounting

ROU asset is the sum of:

Initial

measurem-

ent of lease

liability

Initial direct

costs*

Prepaid

lease

payments

Lease

incentives

received

* Only incremental costs to obtain the lease qualify – no allocation of internal fixed costs is permitted and costs that would have been

incurred even if the lease was not obtained (e.g., legal fees to draft the lease contract) are not initial direct costs.



Example - Initial measurement – ROU assetLessee accounting

— Lessee A:

▪ Incurred $10,000 in initial direct costs (e.g., broker commission)

▪ Prepaid $100,000 at lease commencement

▪ Received a lease incentive of $15,000 at lease commencement

ROU asset is $483,564, which is the sum of:

$388,564 $10,000 $100,000 $(15,000)

Initial

measurem-

ent of lease

liability

Initial direct

costs*

Prepaid

lease

payments

Lease

incentives

received



Subsequent measurement – ROU asset (Finance leases)

— *Amortized, generally on a straight-line basis, over the shorter of the lease term or

useful life of the ROU asset

▪ Together with interest expense, results in a front-loaded pattern of total lease cost

— ASC 360 impairment testing

Lessee accounting

ROU assetBeginning

balance

Accumulated

amortization*

Accumulated

impairment

losses

While finance lease accounting (Topic 842) is substantially similar to capital lease

accounting (current U.S. GAAP), be aware of definitional differences (lease

payments vs. minimum lease payments) and significant changes resulting from

the reassessment requirements and new lease modification guidance.



ASC 360 – Impairment Testing— Potential triggering events (As defined under ASC 360-10-35)

▪ A significant decrease in the market price of a long-lived asset

▪ A significant adverse change in the extent or manner in which a long-lived asset is

being used or in its physical condition

▪ A significant adverse change in legal factor or in the business climate that could affect

the value of a long-lived asset, including an adverse action or assessment by a

regulator

▪ An accumulation of costs significantly in excess of the amounts originally expected for

the acquisition or construction of a long-lived asset

▪ A current period operating or cash flow loss combined with a history of losses or a

projection/forecast that demonstrates continuing losses associated with the use of

long-lived assets

▪ A current expectation that, more likely than not, a long-lived asset will be sold or

otherwise disposed of significantly before the end of its previously estimated useful

life.



Subsequent measurement – ROU asset (Operating leases, FASB only)

Method 1 – Derive the ROU asset from the lease liability

Lessee accounting

Lease

liability

carrying

amount

Unamortized

initial direct

costs

Prepaid/

(accrued)

lease

payments

Unamortized

balance

lease

incentives

received

** The amortization of the right-of-use asset each period is calculated as the difference between the straight-line lease cost for the period

(including amortization of initial direct costs) and the periodic accretion of the lease liability using the effective interest method.

▪ ASC 360 impairment testing

— Once impaired, single lease cost is not

straight-line (pattern, but not presentation is

equivalent to finance lease).

▪ P&L: Straight-line total lease cost

(see next slide)

Method 2 – Amortize the ROU asset

ROU assetBeginning

balance

Accumulated

amortization**



Operating leases (FASB only)


Example: ROU asset subsequent measurement

ROU assetBeginning

balance

Accumulated

amortization

— Lessee A will recognize straight-line lease cost of $109,000 each year of the lease,

which includes: (a) straight-line amortization of the $10,000 in initial direct costs (IDCs)

and (b) straight-line recognition of the $(15,000) lease incentive received.

- ($535,000 in lease payments [$550,000 rent payments − $15,000 lease

incentives] + $10,000 in IDCs) ÷ 5 years = $109,000

— Year 1 Amortization of ROU asset is $85,686

- Lease cost of $109,000 – accretion of lease liability of $23,314 (6% x $388,564)

— Carrying amount of ROU asset at the end of Year 1: $397,878

- $483,564 beg. of Year 1 ROU asset – $85,686 Year 1 amortization



Operating leases (FASB only) (continued)


— Account balances at the end of Year 1:

Example: ROU asset subsequent measurement

$ 411,878 $8,000 $(10,000) $(12,000)

Same as Method 1

$411,878 =

$105,000 (due

beginning of Year 2)

+ 3 additional

remaining annual

payments,

discounted at 6%

$8,000 =

$10,000 initial

IDCs – $2,000

Year 1

amortization

$(10,000) =

$100,000 Year 1

payment –

$110,000 straight-

line operating lease

cost (excl. effect of

IDCs and lease

incentives)

$(12,000) =

$(15,000) initial

lease incentives

+ $3,000 Year 1

accretion

Lease liability

Unamortized

initial direct

costs

Prepaid/

(accrued)

lease

payments

Unamortized

balance lease

incentives

received

$397,878

ROU asset



Operating leases (FASB only)

— Regardless of the method chosen to subsequently measure the operating lease ROU asset, the following represents the effect of the

operating lease in this example on Lessee B’s financial statements throughout the lease term:

ROU asset subsequent measurement

Balance sheet Income statement Cash flows

Date ROU asset Lease liability

Net effect on

equity Single lease cost

Operating cash

outflows (Net)

Lease Commencement 483,564 388,564 95,000 – –

End of Y1 397,878 411,878 (14,000) 109,000 (95,000)

End of Y2 307,291 325,291 (18,000) 109,000 (105,000)

End of Y3 211,208 228,208 (17,000) 109,000 (110,000)

End of Y4 109,000 120,000 (11,000) 109,000 (115,000)

End of Y5 – – – 109,000 (120,000)

Total 545,000 (545,000)



Example - Subsequent measurement – ROU asset (Operating leases, FASB only) (1/3)Lessee accounting – subsequent measurement (ROU asset)


Lease

liability

carrying

amount

Unamortized

initial direct

costs

Prepaid/

(accrued)

lease

payments

Unamortized

balance

lease

incentives

received

— Account balances at the end of Year 1:

$411,878 $8,000 $(10,000) $(12,000)

ROU

asset

$397,878Same as Method 1

$411,878 =

$105,000 (due

beginning of Year 2)

+

3 additional

remaining annual

payments,

discounted at 6%

$8,000 = $10,000

initial IDCs - $2,000

Year 1 amortization

$(10,000) = $100,000 Year

1 payment - $110,000

straight-line operating

lease cost (excl. effect of

IDCs and lease incentives)

$(12,000) = $(15,000)

initial lease incentives

+ $3,000 Year 1

accretion



Example -Subsequent measurement – ROU asset (Operating leases, FASB only) (2/3)Lessee accounting


ROU assetBeginning

balance

Accumulated

amortization**

— Lessee A will recognize straight-line lease cost of $109,000 each year of the lease, which

includes: (a) straight-line amortization of the $10,000 in initial direct costs (IDCs) and (b)

straight-line recognition of the $(15,000) lease incentive received

▪ ($535,000 in lease payments [$550,000 rent payments − $15,000 lease

incentives] + $10,000 in IDCs) ÷ 5 years = $109,000

— Year 1 Amortization of ROU asset is $85,686

▪ Lease cost of $109,000 – accretion of lease liability of $23,314 (6% x $388,564

— Carrying amount of ROU asset at the end of Year 1: $397,878

▪ $483,564 beg. of Year 1 ROU asset - $85,686 Year 1 amortization



Example - Subsequent measurement – ROU asset (Operating leases, FASB only) (3/3)

■ Regardless of the method chosen to subsequently measure the operating lease

ROU asset, the following represents the effect of the operating lease in this

example on Lessee A’s financial statements throughout the lease term:

Reassessments and modifications



Subsequent measurement and remeasurement – Lease liability Lessee accounting

— Measured at present value of unpaid lease payments

throughout the lease term

— No fair value option

— The lease is modified and that modification is not

accounted for as a separate contract

— There is a change in:

- The assessment of the lease term

- The assessment of a purchase option exercise

- The amount probable of being owed under a RVG

— A contingency is resolved resulting in some or all

variable lease payments becoming fixed payments

Subsequent measurement

Lease liability remeasured

when

— Under current U.S. GAAP, lease accounting is not revised after commencement

unless the lease is modified.




Reassessment of lease term and purchase options (Lessees only)Triggering events: Significant events or changes in circumstances within the

lessee’s control

Lessee accounting – lease reassessmentsR

ea

ss

es

s le

as

e t

erm

or

pu

rch

as

e o

pti

on

Constructing significant leasehold

improvements

Significantly modifying or customizing

the asset

Subleasing the asset for a period

beyond the end of the lease term

Making a business decision that is

directly relevant to option exercise

Example triggering events

▪ Lessee elects to exercise an option even though the entity had previously

determined that the lessee was not reasonably certain to do so; or

▪ Lessee does not elect to exercise an option even though the entity had

previously determined that the lessee was reasonably certain to do so.

Or:



Summary Lessee accounting – lease reassessments

Lease payments?

Consideration in

the contract?

Allocation of

consideration?

Discount rate?

Lease

classification?

Lease

modification not

accounted for

as a separate

contract

Change in

lease term

Change in

assessment of

lessee

purchase option

exercise

Change in

amount

probable of

being owed

under RVG

Resolution of

contingency

Do I revise:

Only when there is a triggering

event (as defined)

Whenever relevant facts and

circumstances change

When do I

reassess?N/A



Accounting for a change arising from a reassessmentLessee accounting – lease reassessments

6. If lease classification changes,

adjust recognition & presentation

Change in

lease term

Change in

assessment of

lessee

purchase option

exercise

Change in

amount

probable of

being owed

under RVG

Resolution of

contingency

3. Remeasure lease liability using

original discount rate

2. Remeasure lease liability using

updated discount rate

1. Remeasure and reallocate

‘consideration in the contract’

4. Adjust ROU asset. If ROU asset

reduced to zero => P&L

5. Reassess lease classification at

reassessment date



Lessee accounting for lease modificationsLessee accounting

Does the modification

grant the lessee an

additional ROU1?

Is the additional ROU

priced commensurate

with its standalone

price?

Does the modification

decrease the lessee’s

ROU1?

Account for additional

ROU as a separate

contract

Account for modification as

a full, or partial, early lease

termination. Decrease

carrying amount of ROU

asset on a basis

proportionate to full (or

partial) termination.

Difference between

decrease in lease liability

and ROU asset = gain or

(loss)

Adjust the lease liability

and record an equal and

offsetting change to the

ROU asset

Yes

Yes

Yes

No

No

No

1 Lease term is an attribute of the

lessee’s right to use the underlying

asset (i.e., does not grant the lessee an

additional right of use).

Topic 842 includes

additional guidance when

the original lease was a

finance lease, and the

modified lease is an

operating lease



Accounting steps for lease modificationLessee accounting

1• Remeasure and reallocate the contract consideration to the remaining lease and non-

lease components

2• Remeasure the lease liability to reflect revised lease payments, using a discount rate at

modification effective date

3

• Modifications that decrease lessee’s right-of-use: ROU asset carrying amount reduced on a proportionate basis to the full (or partial) termination of the existing lease. Remainder in P&L.

• Other modifications, adjust ROU asset by the amount of the lease liability remeasurement.

4• Account for IDCs, lease incentives, and other payments in same manner as for a new

lease.

5• Reassess lease classification as of the effective date of the modification based on the

circumstances at that date.

6

• If there is a change in lease classification, adjust the remaining lease cost recognition pattern and presentation in the income statement and statement of cash flows prospectively.



Subsequent measurement and reassessmentsLease liability

— Measured at PV of unpaid lease payments

throughout the lease term

— No fair value option

— The lease is modified and that modification is not

accounted for as a separate contract

— There is a change in:

- The assessment of the lease term

- The assessment of a purchase option exercise

- The amount probable of being owed under a RVG

— A contingency is resolved resulting in some or all

variable lease payments becoming fixed payments

Subsequent

measurement

Lease liability

remeasured when


Under current U.S. GAAP, lease accounting is not revised after commencement unless

the lease is modified.



When to reassess

Change in the

lease term

Change in

assessment of

lessee purchase

option exercise

Change in amount

probable of being

owed under RVG

Resolution of a

contingency

1 2 3 4

Reassess whenever relevant facts or

circumstances change (e.g., market value of

the underlying asset changes)

Reassess ONLY:

— When there is “triggering event”

— An event written into the contract obliges the

lessee to exercise (or not to exercise) an

option

— The lessee elects to exercise an option it

had previously determined that it was not

reasonably certain to exercise

— The lessee elects not to exercise an option

it had previously determined it was

reasonably certain to exercise.



Reassessment of lease term and purchase options

Constructing significant leasehold improvements

Significantly modifying or customizing the underlying asset

Subleasing the underlying asset for a period beyond the

exercise date of an option

Significant Events

or Significant

Changes within

Lessee’s Control –

Example Triggers

Making a business decision that is directly relevant to the

lessee’s ability to exercise or not exercise an option

— Lessee elects to exercise an option even though the entity had previously determined

that the lessee was not reasonably certain to do so

— Lessee does not elect to exercise an option even though the entity had previously

determined that the lessee was reasonably certain to do so



Change in lease term

— At the end of Year 3, Lessee A constructs leasehold improvements that will have significant

economic value beyond the non-cancellable period of the lease such that A is reasonably

certain to exercise the 5-year renewal option. The remaining lease term is now 7 years.

— Lessee A’s incremental borrowing rate at the end of Year 3 is 6.5%.

— Annual payments during the renewal period are $125,000 (payable in advance), increasing by

$5,000 each year.

— Since Lessee A is now reasonably certain to exercise the 5-year renewal option, Lessee A:

- Remeasures the lease liability at the end of Year 3, using a discount rate of 6.5%:

$751,999 (which increases the lease liability balance immediately prior to the

remeasurement date by $523,791)

- Records the following journal entry:

Example

Account Debit Credit

Right-of-use asset 523,791

Lease liability 523,791

- Reassesses lease classification considering the facts and circumstances at the

remeasurement date (i.e., FV and remaining economic life of warehouse at that date)

Build-to-suit lease considerations



Lessee costs relating to construction or design of underlying asset

DOES NOT control the underlying asset being

constructed before the commencement date…Not a sale-leaseback transaction

Controls the underlying asset being constructed

before the commencement date…Apply sale-leaseback guidance in Topic 842

If the lessee:

* Account for costs related to the construction or design of the asset in accordance with other Topics (e.g.,

Topic 360 on PP&E). Payments for the right to use the underlying asset are lease payments regardless of when

paid.

Scenario

▪ An entity negotiates a lease before the underlying asset is available for use by the lessee.

▪ The underlying asset needs to be constructed or redesigned for use by the lessee.

▪ The entity incurs costs related to the construction or design of the underlying asset.*



Lessee control over the underlying asset before the commencement date of the lease

▪ The lessee has the right to obtain the partially-constructed underlying asset at any point during the construction

period (e.g., by making a payment to the lessor);

▪ The lessor has an enforceable right to payment for performance to date and the asset has no alternative use to the

owner-lessor;

▪ The lessee legally owns the asset and, if applicable, the land upon which it is being built;

▪ The lessee controls the land that property improvements will be constructed upon and has not leased the land to the

lessor for substantially all the economic life of the property improvements; or

▪ The lessee has a lease of the land that the property improvements will be constructed upon for at least substantially

all the economic life of the improvements and has not subleased the land to the lessor or an unrelated third party for

substantially all the economic life of the improvements.

Lessee controls the underlying asset being constructed before the commencement date if:*

* Not an all-inclusive list



Lessee control over the asset under construction #1Example

Evaluation

LE would be considered to control the building as it is being

constructed and, therefore, would be within the scope of the

sale-leaseback guidance if:

▪ One or more of the events of default that would permit LE

to exercise an option to acquire the in-process asset are

substantially within LE’s control. For example, if LE is

managing the construction process, and construction

delays trigger the purchase option, LE would control the

underlying asset just as if the purchase option was non-

contingent.

▪ In contrast, if the events of default are not within LE’s

control, then LE would not control the building while it is

being constructed

Facts

▪ Lessee LE enters an agreement to lease a building from

Lessor LR that will be constructed

▪ LE agrees to manage the construction process

▪ The agreement permits LE to acquire the in-process asset

from LR, but only in the case of certain events of default.

▪ None of the other indicators on the prior slide (or other

factors) suggest LE controls the underlying asset as it is

being constructed



Lessee control over the asset under construction #2Example

Evaluation

In this scenario, LE controls (i.e., is the accounting owner of)

the building as it is being constructed, because:

— LE controls the land on which the building will be

constructed, and

— The lease of the building does not both (1) grant LR the

right to control the use of the land before the beginning of

the construction period, and (2) permit LR to control the

use of the land for substantially all of the economic life of

the building.

Facts

▪ Lessee LE and Lessor LR enter into a contract whereby

LR will construct a building with a 40-year economic life to

LE’s specifications and lease that building to LE once it is

complete.

▪ LE does not legally own the building and does not have a

right under the contract to obtain the building while it is

under construction.

▪ Although the building is being developed to LE’s

specifications, it has an alternative use to LR.

▪ LE controls the land on which the building is to be

constructed. LE agrees to lease the underlying land to LR

for 25 years, beginning at the end of the construction

period.

▪ The contract does not permit LR to renew the ground

lease.



Comparison of current guidance versus new guidanceExample

The lease agreement does not contain any indicators as per Topic 842 that Restaurant LE controls the

underlying asset during the construction period.

In exchange for bearing this cost, REIT LR provides Restaurant LE with a tenant improvement allowance

equal to the budgeted amount for the standard flooring and HVAC.

Restaurant LE agrees to construct certain portions of the space for which LE’s use requires greater than the

standard specifications, including an upgraded floor-drain system, and a high-capacity HVAC system.

Restaurant LE agrees to lease from REIT LR a basic retail storefront in an enclosed shopping mall that is

under construction.



Comparison of current guidance versus new guidance (continued)Example

Current U.S. GAAP

— LE evaluates whether its involvement in construction of the underlying

asset results in LE having substantially all of the construction period risks.

— As part of this evaluation, LE considers whether the commitment to pay

for certain construction costs causes it to fail the maximum guarantee test.

— LE must also consider whether the entirety of the build-to-suit agreement

violates any of the specified automatic indicators of ownership.

New U.S. GAAP

— LE evaluates whether it controls the underlying asset during the

construction period.

— If LE does not control the building, it does not control the HVAC or

floor-drain system it is paying for. It is, in effect, paying for a portion

of LR’s asset. Therefore, LE accounts for the cost of those building

improvements as lease payments to LR.



Comparative period Comparative period Current period

December 31, 2019

Effective date

(date of adoption)

January 1, 2019

Beginning of earliest

period presented

January 1, 2017 December 31, 2018

Derecognize Topic 840 build-to-suit assets and liabilities at the

later of:

— Beginning of earliest comparative period presented, or

— Date the lessee is determined to be accounting owner.

Record any difference as an adjustment to equity at that date.

If construction is completed prior to the effective date, lessee is

not required to assess whether it was the accounting owner

under Topic 842 for purposes of modified retrospective

presentation.

Construction completed during comparative periods

Transition guidance for build-to-suit (BTS) transactions

Construction completed prior to

comparative periods

If transaction resulted in sale-

leaseback, apply general transition

guidance to lease.

If transaction resulted in failed

sale-leaseback, derecognize Topic

840 build-to-suit assets and

liabilities at beginning of earliest

comparative period presented.

Record any difference as an

adjustment to equity at that date.

Evaluate whether lessee is the accounting owner under

Topic 842

If the lessee is accounting owner under Topic 840 and

Topic 842:

— Continue to recognize the BTS assets and liabilities

until they qualify for derecognition in accordance with

the sale-leaseback requirements in Topic 842.

If the lessee is accounting owner under Topic 842 but

not Topic 840:

— Recognize BTS assets and liabilities back to later of

beginning of earliest period presented or start of

construction

If the lessee is not the accounting owner under Topic

842:

— Derecognize the assets and liabilities that were

recognized solely as a result of a transaction’s BTS

designation under Topic 840 at the later of (a) the

beginning of the earliest period presented and (b) the

date the lessee is determined to be the accounting

owner of the asset under Topic 840. Record any

difference as adjustment to equity at that date.

— Apply the general lessee transition guidance for the

lease itself.

Construction period in progress at effective date

Leases acquired in a business combination



Leases acquired in a business combination - overview

* Fair value of the underlying asset in this context takes into account the terms and conditions of the acquired lease.

Acquiree is a lessee Acquiree is a lessor

Operating and finance leases Operating leases Sales-type and direct

financing leases

Lease liability

Present value of the

remaining lease payments

Right-of-use asset

Equal to the liability,

adjusted for any

favorable/unfavorable

terms

Property, plant, and

equipment

Underlying asset at fair

value

Lease receivable

Present value of the

remaining lease payments

and guaranteed residual

value

Asset or liability

Favorable/unfavorable

terms

Intangible assets

Associated with the lease

Unguaranteed residual

asset

Difference between fair

value of underlying asset*,

and lease receivable

Intangible assets

Associated with the lease



Leases acquired in a business combination - other considerations

* The terms and conditions of a lease, including the nature of terms as off-market, if applicable, are taken into account in

determining the fair value of the underlying asset in a sales-type or direct financing lease, and therefore no separate

asset or liability is recognized.

Intangible assets

Entry into a controlled

market

In-place lease asset or

customer relationship

Adjustments for market terms

Similar to a favorable/unfavorable operating lease

asset/liability

Component of the right-of-

use asset when acquiree is

a lessee

Separate asset/liability

when acquiree is a lessor in

an operating lease*



Acquisition of lessee

Company AR acquires Lessee LE, which leases its main distribution center from

Lessor LR. The distribution center comprises a large building and surrounding land

near a major interstate highway interchange. The lease has been properly classified

as an operating lease.

Key facts:

▪ Lease term: 25-year original term at commencement, 19-year remaining term at

acquisition (i.e., acquisition occurs on first day of year 7 of the lease)

▪ Contractual lease payments: $1 million annually, with 3% escalation annually after year

1 ($1,194,052 lease payment for Year 7)

▪ Fair value of property at lease commencement: $30 million

▪ Remaining economic life of building at lease commencement: 45 years

▪ LE’s incremental borrowing rate at commencement: 7%,

▪ AR’s incremental borrowing rate at acquisition date: 8%

▪ Accrued rent liability at acquisition: $2,281,816

▪ There are no identifiable intangible assets associated with the lease

Example



Acquisition of lessee (continued)Example

Scenario 1:

Assume that the remaining contractual lease payments

approximate market rates

Scenario 2:

Assume that the Year 7 lease payment approximates an

at-market lease payment. However, current market

conditions would call for a 4% annual escalation beginning

in Year 8 through the remainder of the lease term (rather

than 3%).

AR recognizes a ROU asset and lease liability on the

acquisition date as follows:

— Lease liability of $14,177,970 (the present value of the

contractual payments using a discount rate of 8%)

— Right-of-use asset of $14,177,970, which equals the

lease liability because lease is at market terms

AR recognizes the same lease liability as in Scenario 1

AR measures the right-of-use asset as follows:

Amount of the lease liability: $14,177,970

Off-market adjustment*: 1,100,451

Total ROU Asset: $15,278,421

* Calculated as the difference between contractual and at-

market lease payments, discounted at the same 8%

discount rate.



Transition guidance for assets and liabilities from previous business combinationsThe process of transitioning existing assets (liabilities) arising from favorable (unfavorable)

lease terms in previous business combinations depends on the combination of status as

lessee or lessor and the classification of the lease under current U.S. GAAP:

Lease is a(n): Entity is the lessee Entity is the lessor

Operating lease Asset (liability) is derecognized, with a

corresponding adjustment to the ROU

asset

No Change

Finance lease (lessee)

Sales-type/direct financing

lease (lessor)

N/A Asset (liability) is derecognized, with a

corresponding adjustment to beginning

retained earnings

Lessor accounting



Lease classification test (Part A)Lessor accounting – lease classification



Sales-type

lease

Go to Part B tests

Lease term = major part (e.g., 75%) of remaining economic

life?1,2

No

No

No

Yes

Yes

Yes

PV of 1) lease payments + 2) lessee RVG ≥ substantially all

(e.g., 90%) FV?

Specialized asset with no alternative use to lessor?3

No

NoYes

Yes

Part A tests

2 If the commencement date is at or near the end of the underlying asset’s economic life, this test does not apply3 Refer to discussion of this criterion on Slide 33

— Assessment criteria

are similar to current

U.S. GAAP, but

without explicit

bright lines

1 Comparison to current

U.S. GAAP



Lease classification test (Part B)Lessor accounting – lease classification

Does the present value of the sum of (1) the lease payments

and (2) any residual value guarantee from the lessee or a third

party unrelated to the lessor equal or exceed substantially all

(e.g. 90%) of the underlying asset’s fair value?

Is it probable that the lessor will collect the lease payments plus

any amount necessary to satisfy a residual value guarantee?

Operating

lease

Yes

Yes

No

No

Part B tests

Direct financing

lease



Additional lease classification considerations for lessorsLessor accounting – lease classification

— Determine the present value of lease payments and residual value guarantees

using the rate implicit in the lease

Initial direct costs deferred2

Fair value ofunderlying asset1

Present value of estimated future residual value

Present value of lease payments

Rate implicit inthe lease

1. FV of underlying asset is reduced by amount of any investment tax credit related to underlying asset that is

retained and expected to be realized by lessor.

2. IDCs are not deferred if lease is a sales-type lease and the FV of the asset is different from its carrying

amount at lease commencement.

Solely for the purpose of determining whether a lease is a sales-type lease, the discount

rate used in the present value test assumes no IDCs will be deferred if at the commencement

date the fair value of the underlying asset is different from its carrying amount.



Thresholds for lease classification tests

— Paragraph 842-10-55-2 permits (but does not require) use of “bright-line” thresholds

when performing the lease term and present value tests:

Threshold Permitted “bright line”

Major part of the asset’s remaining

economic life

≥ 75% = a major part

Substantially all of the asset’s fair value ≥ 90% = substantially all

At or near the end of the asset’s economic

life

≤ 25% of the total economic life remaining

= at or near the end

— May be reasonable to conclude that for some assets < 75% = major part of its

remaining economic life if the asset degrades in economic utility in a significantly

front-loaded manner, while for others > 75% ≠ major part of its remaining economic life

if asset holds its economic utility or value

— Because substantially all is used elsewhere in U.S. GAAP and generally considered

similarly, may not be substantial flexibility around that threshold

— Generally there is not flexibility around 25% at or near the end threshold because it

relates to an exception to the classification principle



New to topic 842

— Consider:

Alternative use test

Contractual restrictions Practical limitations

— Underlying asset being of a highly specialized nature or subject to highly specialized

circumstances is key to meeting this test.

- Alternative use test not met solely because of contractual restrictions

- Not another ‘lease term’ test

— When considering alternative use, consider the characteristics of the asset that will

ultimately be returned to the lessor at the end of the lease term (i.e., customizations or

modifications agreed or committed at lease commencement)



Key classification differences vs. current U.S. GAAP

Fair value of underlying asset compared to its carrying amount no longer dictates whether lease is a

sales-type or a direct financing lease.

Leveraged lease classification and accounting no longer exists prospectively from the effective date of

Topic 842.

Real estate leases no longer have special rules (e.g., transfer of title to be a sales-type lease) – they are

subject to the same guidance as all other leases.

Collectibility uncertainties do not preclude a lease from being classified as a sales-type lease. However,

a lease cannot be classified as a direct financing lease if the collectibility test is failed.

No ‘important uncertainties about unreimbursable costs’ test in Topic 842.

Exception pertaining to leases entered into at or near the end of the economic life of the asset only

applies to lease term test, not the present value test.



Example: Forklift leaseLessor accounting – lease classification

Lessor leases a forklift to Lessee for 3 years.

Lease payments (annual, paid in arrears) $11,000

Transfer of ownership, purchase option, or renewal option None

Fair value of forklift $40,000

Carrying amount of forklift $36,000

Initial direct costs (Topic 842) $1,500

Remaining economic life 5 years

Estimated future residual value $12,500

Residual value guarantee provided by third-party $9,200

Rate implicit in the lease 4.15%

Rate implicit in the lease (IDCs not considered) 5.88%

Collectibility of lease payments and RVG at commencement Probable



Example: Forklift lease



Sales-type

lease

Go to Part B tests

Lease term = major part (e.g., 75%) of remaining economic

life?1

No

No

No

Yes

Yes

Yes

PV of 1) lease payments + 2) lessee RVG ≥ substantially all

(e.g., 90%) FV?


No

NoYes

Yes

Part A tests

Calculations:

■ Lease term ÷

remaining economic

life of forklift = 60%

■ PV lease payments

(discounted at

5.88%): $29,469

■ PV lease payments ÷

FV of forklift = 74%

Lessor accounting – lease classification



Example: Forklift lease

Calculations:

■ PV (lease payments

+ RVG), discounted

at 4.15%: $38,579

■ PV (lease payments

+ RVG) ÷ FV of

forklift = 96%

Does the present value of the sum of (1) the lease payments

and (2) any residual value guarantee from the lessee or a third

party unrelated to the lessor equal or exceed substantially all of

the underlying asset’s fair value?

Is it probable that the lessor will collect the lease payments plus

any amount necessary to satisfy a residual value guarantee?

Operating

lease

Yes

Yes

No

No

Part B tests

Direct financing

lease

Lessor accounting – lease classification



Operating leasesLessor accounting

Lessor Lessee

Right to use

underlying

asset

Lease payments

— Lease income recognized generally on a straight-line basis

— Underlying asset remains on the lessor’s balance sheet and continues to be

depreciated

Underlying asset

No de-recognition of

underlying asset



Sales-type and direct financing leasesLessor accounting

Lessor Lessee

Right to use

underlying

asset

Lease payments

Lease Receivable

Right to receive future

lease payments +

guaranteed residual value

Unguaranteed Residual

Asset

Unguaranteed portion of

estimated residual value

Total Net Investment in

the Lease*

— Lease receivable and unguaranteed residual asset discounted using rate implicit in the lease.

— Interest income is accrued on the net investment in the lease using the rate implicit in the lease.

— The lessor’s entire net investment in the lease is assessed for impairment using the financial

instruments impairment guidance.

*If the lease is a direct financing lease, any selling profit is deferred and deferred selling profit reduces the net investment in the lease



Sales-type vs. direct financing leasesLessor accounting

Sales-type leases Direct financing leases

Selling profit

Recognize at lease commencementDefer as a reduction of the net investment

in the lease

Selling loss

Recognize at lease commencement Recognize at lease commencement

Initial direct costs*

■ FV underlying asset ≠ carrying amount

Expense at lease commencement

Exclude from determination of rate

implicit in the lease

■ FV of underlying asset = carrying

amount

Defer and include in net investment

in the lease

Include in determination of rate

implicit in the lease

■ Defer and include in net investment in

the lease

■ Include in determination of rate implicit

in the lease

* Topic 842’s definition of initial direct costs is different from current US GAAP



Direct financing lease with selling profit

Same example used for lease classification

Example

Lessor leases a forklift to Lessee for 3 years.


Transfer of ownership, purchase option, or renewal option None

Fair value of forklift $40,000

Carrying amount of forklift $36,000

Initial direct costs (Topic 842) $1,500



Residual value guarantee provided by third-party $9,200


Rate implicit in the lease (IDCs not considered) 5.88%

Collectibility of lease payments and RVG at commencement Probable



Direct financing lease with selling profit (continued)

1. Subsequent to lease commencement, earned selling profit recognition = total income* – interest on lease receivable –

unguaranteed residual asset accretion

— *Total income (incl. deferred profit release) each year is calculated as the net investment in the lease × the

discount rate that would have been required for the sum of the lease receivable and the unguaranteed residual

asset to equal the forklift’s carrying amount + the deferred IDCs (9.00%)

2. Calculated using the rate implicit in the lease (4.15%) – i.e., the discount rate that makes the PV of the (lease payments

+ estimated future residual value) = the FV of the forklift at lease commencement of $40,000 + the deferred IDCs of

$1,500

Example

Balance sheet Income statement

End

of

year

Lease

receivable2

Unguar.

resid.

asset2

Deferred

selling

profit1

Net invest.

In lease

Interest on

receivable2

Residual

accretion2

Earned

selling

profit1

Total

income*

0 $38,579 $2,921 ($4,000) $37,500 $ – $ – $ – $ –

1 29,182 3,042 (2,351) 29,873 1,603 121 1,649 3,373

2 19,394 3,168 (1,002) 21,560 1,212 126 1,349 2,687

3 9,200 3,300 -- 12,500 806 132 1,002 1,940

Totals $3,621 $379 $4,000 $8,000




Note 1: Lease income is net of IDCs amortization and includes earned selling profit; therefore, the amounts in these 2 lines are

illustrative only (for comparison purposes to current U.S. GAAP).

Example

Topic 842 Commencement Year 1 Year 2 Year 3 Total

Lease income $ – $ 3,373 $ 2,687 $ 1,940 $ 8,000

Selling profit1 – 1,649 1,349 1,002 4,000

IDCs amortization1 – (627) (505) (368) (1,500)

Current U.S. GAAP2 Commencement Year 1 Year 2 Year 3 Total

Interest income $ – $ 2,351 $ 1,843 $ 1,306 $ 5,500

Selling profit 4,000 – – – 4,000

Expense IDCs (1,500) – – – (1,500)

Lease income $ 2,500 $ 2,351 $ 1,843 $ 1,306 $ 8,000

Note 2: Lease would be a sales-type lease under current U.S. GAAP



Collectibility – lease classification considerationsLessor accounting

The assessment of collectibility occurs after the ‘Part A’ classification tests.

Collectibility issues do not prevent classification as a sales-type lease.

Changes in assessment of collectibility after commencement date do not change

lease classification (whether change in collectibility is positive or negative).

Example: A lease classified as an operating lease at commencement date solely

because of collectibility issues is not reclassified as a direct financing lease if

collectibility subsequently becomes probable.

However, a lease cannot be classified as a direct financing lease if collectibility of

the lease payments and RVG is not probable at lease commencement.



Collectibility – sales-type leases (1 of 2)Lessor accounting

Collectibility of lease payments and lessee residual value guarantee is assessed

after a lease has already been classified as a sales-type lease.

If collectibility is not probable, the lessor:

Does not derecognize the

underlying asset!

Recognizes lease payments

(including variable lease payments)

as a deposit liability until one of the

following occurs:

a) collectibility becomes probable

b) contract is terminated and lease

payments received are non-

refundable

c) lessor has repossessed asset,

has no further obligation to

lessee, and lease payments

received are non-refundable



■ Derecognize the underlying asset

■ Derecognize the deposit liability

■ Recognize a net investment in the

lease

■ Recognize selling profit (loss)

Collectibility – sales-type leases (2 of 2)Lessor accounting

If collectibility becomes probable, the lessor will:

Selling

profit

(loss)

Lease

receivable

Carrying

amount of

deposit

liability

Carrying amount of

underlying asset, net of

unguaranteed residual

asset

When one of the two designated events occurs:

■ Derecognize the deposit liability

■ Recognize lease income equal to the derecognized deposit liability



Sales-type lease – Collectibility not probableExample

Lessor leases a bulldozer to Lessee for 5 years.


Transfer of ownership, purchase option or renewal option None

Fair value of bulldozer $72,000

Carrying amount of bulldozer $65,000



Residual value guarantee provided by lessee $14,000


Collectibility of lease payments and RVG at commencement Not probable

Lease is classified as a sales-type lease even though collectibility is not probable.



Sales-type lease – Collectibility not probable (continued)Example

— Because collectibility is not probable at lease commencement, Lessor:

- Does not derecognize the asset nor recognize a net investment in the lease,

- Does not recognize selling profit,

- Continues to depreciate the bulldozer,

- Recognizes lease payments received as a deposit liability.

— In Years 1 and 2, Lessor concludes collectibility is still not probable. At the end of

Year 3, Lessee makes 3rd lease payment timely. Considering all relevant facts and

circumstances, including 3 timely payments and an improvement in Lessee’s financial

condition, Lessor determines collectibility is now probable.

— Balances at the end of Year 3:

- Carrying amount of bulldozer: $37,142 ($65,000 – [$9,286 depr. × 3 years])

- Deposit liability: $40,500 (3 payments of $13,500)



Sales-type lease – Collectibility not probable (continued)

— Journal entry at the end of Year 3

Example


PP&E 65,000

Accumulated depreciation 27,858

Deposit liability 40,500

Net investment in lease 40,588

Selling profit 43,946

— Worksheet for journal entry

PV of 2 lease payments 25,139

PV of Lessee RVG 12,723

Lease receivable 37,862

PV unguar. residual value 2,726

Net investment in lease 40,588

Lease receivable 37,862)

Deposit liability 40,500)

Carrying amount bulldozer (37,142)

Unguar. Residual value 2,726)

Selling profit 43,946

Note: Lessor uses rate implicit in the lease at lease commencement (i.e., 4.90%) to calculate the net

investment in the lease at the end of Year 3 when collectibility becomes probable.



Leases other than sales-type leasesCollectibility

If collectibility of lease payments and any residual value guarantee(s) is not

probable at the commencement date, the lease is classified as an operating lease.

Cumulative lease income is limited to the lesser of:

a) Income that would be recognized

for an operating lease (generally

straight-line)

b) Lease payments, including variable lease

payments, collected from the lessee

If collectibility becomes probable, any difference between a) and b) above is

recognized as a current-period adjustment to lease income.



Lessor accounting – Collectibility not probable

— Assume the same bulldozer lease as in previous example, except that:

- The residual value guarantee is provided by a third-party, not Lessee

- The lease payments increase by $1,000 each year (Year 1: $13,500)

— Because collectibility of the lease payments and the third-party residual value

guarantee is not probable at lease commencement => operating lease

Example

Year 1 & 2

— Collectibility not

probable

— Lessor recognizes

lease income when

Lessee makes lease

payments


lease income of

$13,500 in Year 1 and

$14,500 in Year 2

(total = $28,000)

Year 3

— Collectibility becomes

probable at end of year


lease income of

$18,500 in Year 3,

calculated as:

— (S/L lease income of

$15,500 x 3 years) –

(lease income

previously recognized

of $28,000).

Year 4 & 5

— Collectibility is probable


lease income of

$15,500 in each of

years 4 and 5)



Measure the consideration in the contract (Lessor)

Consideration in the contract (Lessee)

Are there any other variable payments that specifically relate to either:

The lessor’s efforts to transfer one


not leases?

An outcome from transferring one


not leases?OR

No

adjustment

necessary

NoPa

rt 1

Apply variable consideration requirements in Topic 606 to measure the

amount to be included in the consideration in the contract:

YesYes

Step 1: Estimate the amount using

the expected value or most likely

amount

Step 2: Determine the portion (if

any) of that amount for which it is

probable that a significant revenue

reversal will not subsequently

occur

Pa

rt 2

Consideration in the contract (lessor)



Separate and allocate consideration to lease and non-lease components

Lessee Lessor

When there is an observable

stand-alone price for each component:

Unless accounting policy elected (see

below), separate and allocate based

on the relative stand-alone price of

components

Always separate and allocate

following the Topic 606 transaction

price allocation guidance

(i.e., generally on a relative

stand-alone selling price basis)When there is not an observable

stand-alone price for some or all

components:

Estimate the stand-alone price,

maximizing the use of observable

information

Taxes and insurance on the property Activities that do not transfer a good or service to the lessee (or solely

reimburse costs of the lessor) are not components of a contract and do not

receive an allocation of the consideration in the contract

Accounting policy election by class of

underlying asset

Account for lease and nonlease

components together as a single

lease component

Important Reminder – Allocation to lease and non-lease components is critical, especially as a result of

required disclosures.



Executory costs

The lessee makes variable payments, either to the

lessor or to a third party, for items like property taxes

and insurance.

Payments of lessor costs such as property taxes and

insurance are fixed as part of the rental payment

specified in the contract.

Gross lease Net lease

Executory costs – A lessee’s reimbursement or payment of the lessor’s property taxes and insurance is an example of

activities (or costs of the lessor) that do not transfer a good or service to the lessee.

Therefore, fixed payments attributable to such activities or costs are part of the consideration that is then allocated to

the separate lease and non-lease components.

Non-lease component revenue recognition method



Non-lease component revenue recognition method

Identification of non-lease components

(maintenance, other services)

Topic 842

Identify the performance

obligations in the contract

Topic 606

Measure the consideration and

allocate

Topic 842 and 606

Recognize revenue for non-lease component

Topic 606

Lessor Lease Modifications



Lessor accounting for a lease modification that is not a separate contract –Original lease is a direct financing leaseLessor accounting – lease modifications

If modified lease is a

Operating lease

Sales-type lease

Carrying amount of underlying asset

=

Net investment in original lease,

immediately prior to effective date of modification

Account for modified lease in accordance with sales-type

lease guidance in Subtopic 842-30 with effective date of

modification as commencement date of lease1

Direct financing lease

Adjust discount rate so that initial net investment in

modified lease

=

Carrying amount of net investment in original lease


1 In calculating the selling profit (loss) on the lease:

- The fair value of the underlying asset is its fair value at the effective date of the modification; and

- The carrying amount of the underlying asset is the carrying amount of the net investment in the original lease

immediately before the effective date of the modification.



Lessor accounting for a lease modification that is not a separate contract –Original lease is a sales-type leaseLessor accounting – lease modifications

If modified lease is a

Operating lease

Sales-type lease or

direct financing lease

Carrying amount of underlying asset

=

Net investment in original lease,


Adjust discount rate so that initial net investment in

modified lease

=

Carrying amount of net investment in original lease




Effect of contract modifications on separation and allocation

Effect on:

Separation conclusionsSeparation conclusions may be affected by the addition of lease or non-lease

components and, therefore, are reassessed

Allocation conclusions The remeasured ‘consideration in the contract’ is allocated on a relative stand-alone

selling price basis based on information at the effective date of the modification



Summary of key differences from U.S. GAAP (1 of 3)Lessor accounting

Changes in lease

classification between sales-type and direct

financing

• No longer differentiated by whether there is manufacturer/dealer profit or loss.

• Now differentiated by whether lessor effectively transfers control of the underlying asset to lessee or transfers substantially all of the risks/benefits of ownership of underlying asset to lessee and an unrelated third party.

Recognition of selling profit

• Selling profit arising from direct financing leases is deferred and recognized over lease term.

Narrowed definition of initial direct

costs (IDCs)

• IDCs include only those incremental costs of a lease that would not have been incurred if the lease had not been executed.

• Allocated internal employee costs and other costs that would be required to be paid even if the lease was not executed (e.g., most legal fees) are not IDCs.




Allocation of consideration in

the contract to lease and non-

lease components

• Lessors always separate lease from non-lease components

• Apply transaction price allocation guidance in new revenue standard.

• Lessors separate lease and non-lease components and allocate consideration between them based on revenue recognition guidance.

Executory costs

• Executory costs that do not represent payments for a good or service are allocated to the lease and non-lease components; they are not excluded from lease classification and certain other aspects of lease accounting.

Collectability

• Leases with collectability uncertainties are not precluded from sales-type lease classification.

• New guidance about lease income recognition when collectability of the lease payments, plus any amounts necessary to satisfy residual value guarantees, is not probable.




Leases with significant

variable payments

• Leases with entirely or predominantly variable payments may be classified as sales-type or direct financing leases.

Lease modifications

• Substantially different guidance on lease modifications aligns more closely with contract modification accounting in new revenue recognition guidance.

• Lease classification is reassessed on a lease modification that is not accounted for as a separate contract.

• Lessor accounting for a lease modification depends on the classification of the original and the modified lease.

Leveraged leases

• Leveraged lease classification and accounting is eliminated prospectively.

• Lessors continue to account for leveraged leases that commenced before the effective date in accordance with ASC 840, unless lease is modified on or after the effective date of ASC 842.

Other issues



Subleases

Head lessor

Head lessee/

intermediate lessor

(sublessor)

Sublessee*

— Apply lessor accounting

— Apply lessee accounting

— Apply lessee accounting to the head lease

— Apply lessor accounting to the sublease

— Generally present gross

* Sublease classification based on underlying asset for U.S. GAAP; ROU asset for

IFRS

— Most U.S. GAAP subleases will be classified as operating leases by sub-lessor

— Most IFRS subleases will be classified as finance leases by sub-lessor

Subleases



Sale-leaseback transactions - overview

Leaseback

Sale

Buyer-lessorSeller-lessee

Leaseback is

accounted for using the

lessee right-of-use

model

Sale is recognized in

accordance with

applicable GAAP

Purchase is recognized

in accordance with

applicable GAAP

Each component of the

transaction is assessed

separatelyGain on sale* is

adjusted for

off-market terms

For a sale to occur,

transaction must meet

ASC 606 requirements

for a sale

* For IFRS, gain on sale is restricted to the residual interest in the underlying asset. For U.S. GAAP, gain on sale is based on entire

underlying asset.

Sale-leaseback transactions



Step 1: Does a contract exist? (Topic 606)Sale-leaseback transactions

…collection of

consideration is

probable

…rights to goods or

services and payment

terms can be

identified

…it has commercial

substance

…it is approved

and the parties are

committed to

their obligations

A contract

exists if…

— A contract is an agreement between two or more parties that creates enforceable

rights and obligations. Enforceability is a matter of law. Contracts can be written,

oral, or implied by an entity’s customary business practices. Additionally:



Step 5: Transfer of control at a point in time (Topic 606)Sale-leaseback transactions

...a present

obligation to

pay

…legal title...physical

possession

...risks and

rewards of

ownership

— The guidance in 606-10-25-30, which 842-40-25-1 links to for purposes of

determining whether a sale has occurred in a sale-leaseback transaction, relies on

the control principle and specified indicators of the transfer of control.

— Control Principle (606-10-25-25) – Control of an asset refers to the ability to

direct the use of, and obtain substantially all of the remaining benefits from, the

asset. Control includes the ability to prevent other entities from directing the use of,

and obtaining the benefits from, an asset.

...accepted

the asset

Indicators that control has passed include a customer having…



Additional sale/purchase considerationsSale-leaseback transactions

— If the leaseback would be classified as a

finance (or sales-type) lease, no

sale/purchase of the asset occurs and the

transaction is accounted for as a financing

arrangement

Classification of the

leaseback

Seller-lessee repurchase

options

— Preclude sale/purchase accounting unless

both criteria are met:

▪ Option is exercisable only at the then-

prevailing fair value of the asset at the

exercise date

▪ There are alternative assets, substantially

the same as the transferred asset, readily

available in the marketplace

According to the FASB, this 2nd criterion cannot

be met for real estate assets because real

estate is ‘unique’. Therefore, any repurchase

option for a real estate asset will preclude

sale/purchase accounting.



Example: Sale-leaseback accounting – Does sale/purchase occur?— Seller-Lessee SL enters into a contract with Buyer-Lessor BL to sell and lease back

a truck.

— Title to the truck transfers to BL at commencement of the leaseback

— Payment of the transaction price is due to SL at commencement of the leaseback

Additionally, the following facts are relevant:

Remaining economic life of the truck 5 years

Fair value of the truck at the commencement date $10,000

Leaseback term 3 years

Fixed leaseback payments, payable annually in arrears $2,800

SL’s incremental borrowing rate 7%

Expected residual value $3,000

Residual value guarantee None

Repurchase option None

Sale is recognized and the leaseback is classified as an operating lease.




Example: Sale-leaseback accounting – Does sale/purchase occur? (alternative scenario)

Consider if: The implications are:

The agreement contains a seller-lessee

repurchase option with a fixed exercise

price

Any repurchase option with a fixed exercise price precludes sale

accounting; therefore the sale-leaseback transaction is accounted for

as a financing arrangement by both parties.

The agreement contains a seller-lessee

repurchase option with a variable

repurchase price that is set based on the

fair value of the truck at the time of option

exercise

Because the exercise price is the then-prevailing fair value of the truck

at the date of option exercise, if there are equivalent trucks readily

available in the marketplace, this repurchase option would not

preclude the sale from being recognized.

The term of the leaseback is 4 years

instead of 3

The longer leaseback term results in classification of the leaseback as

a finance lease; classification of a leaseback as a finance lease

precludes accounting for the transaction as a sale and a leaseback.

Therefore the sale-leaseback transaction is accounted for as a

financing arrangement by both parties.

The seller-lessee provides the lessor with

a significant residual value guarantee

Judgment is required when evaluating the effect of residual value

guarantees. A residual value guarantee provided by the seller-lessee

may suggest that the buyer-lessor has not taken on the significant

risks and rewards of ownership of the asset, which is one of the

indicators to consider in evaluating whether control of an asset has

transferred to the buyer-lessor.

Now let’s consider the following alternative facts, and the impact that they may have on whether a

sale occurs:




Comparison to current U.S. GAAPSale-leaseback transactions

Topic What’s changed?

Real estate

assets and

assets other

than real estate

— The same guidance applies to all sale-leaseback transactions, regardless of the

nature of the underlying asset (i.e., no separate guidance for sale-leaseback

transactions of real estate assets and assets other than real estate)

— Sale-leaseback accounting will be easier to achieve for real estate than under

current U.S. GAAP, but more difficult for assets other than real estate

“Failed

purchase”

accounting

— Buyer-lessors are required to account for a sale-leaseback transaction as a

failed purchase if the transaction does not meet the requirements for a sale in

842-40-25-1

Accounting for

the

sale/purchase

— A sale occurs only if the “Step 1” and “Step 5” guidance in Topic 606 is met.

— A substantive repurchase option for the seller-lessee precludes sale accounting

except as follows:

▪ Seller-lessee repurchase option does not preclude sale accounting for sale-leaseback

transactions of non-real estate if 1) the option is exercisable only at fair value at date of

exercise and 2) there are alternative assets, substantially the same as the transferred

asset, readily available in the marketplace (FASB Only)

— Regardless of the guidance in Topic 606, there is no sale (or purchase) if the

leaseback would be a finance lease for the seller-lessee (or sales-type lease for

the buyer-lessor) (FASB only)

— A seller-lessee will measure the gain on sale as the amount by which the selling

price of the underlying asset exceeds its carrying amount, unless the sales price

is not at market terms



Example: Sale-leaseback transaction at market terms— Seller-Lessee SL enters into a sale-leaseback of a forklift with an unrelated third-party (Buyer-

Lessor BL)

— Information re: the sale-leaseback of the forklift is as follows:

Amount of gain

recognized under Topic 842)?

1. Sale price (and fair value) of forklift $50,000

2. Noncancellable term of leaseback 3 years

3. Remaining economic life of forklift at leaseback commencement 6 years

4. Present value of contractual leaseback payments $20,850

5. Carrying amount of forklift at leaseback commencement $30,000

There are no renewal or repurchase options in the agreement.

$20,000

(#1 – #5)




Example: Sale-leaseback transaction at market terms (cont’d)

Party A transfers ownership of the underlying asset to Party B.

Party B transfers the right to use the asset to Party A.

Party B

(Buyer-Lessor)

$50,000Buyer-Lessor’s

Underlying Asset

The seller-lessee sells the

entire underlying asset to

the buyer-lessor (gain =

$20,000)$30,000

Carrying Amount of Underlying Asset at

Transaction Date

$20,850

Measurement of

ROU Asset

Party A

(Seller-Lessee)

The seller-lessee obtains a

new right to use the

underlying asset (i.e. the

ROU asset)




Accounting for “off-market” terms in a sale-leaseback transaction

Are thecontractual lease payments equal to fair market value

lease payments?

YES

Account for the transaction based on its

contractual terms – there is no adjustment for “off-

market” terms

NO

Is the sales priceequal to the fair value of

the underlying asset? NO

YES

EXCESS:Recognize a financial

liability (i.e., additional financing)

DEFICIENCY: Recognize as prepaid

rent (i.e., increase ROU asset)

Is thefair value of the

underlying asset more readily determinable than the fair

market value leasepayments?

Do thecontractual lease payments

exceed fair market value lease payments?

Does the sales priceexceed the fair value of the

underlying asset?

YES

NO

NO

YES

NO

YES




Example: Sale-leaseback transaction at “off-market” termsAssume the same facts as the previous example except as follows:

1. Sale price of forklift $55,000

2. Present value of leaseback payments at contractual rate $26,000

3. Present value of leaseback payments at estimated market rate $20,500

4. Fair value of forklift at leaseback commencement $50,000

5. Carrying amount of forklift at leaseback commencement $30,000

Assume: the fair value of the forklift is more readily observable than the market

rentals.

Amount of additional financing

to recognize under the Boards’

new standards?

$5,000

(#1 - #4)

ADJUSTED amount of gain to

recognize under Topic 842?

$25,000 (#1 - #5) -

$5,000 (the additional financing)

= $20,000




Example: Sale-leaseback transaction at “off-market” terms (cont’d)Seller-Lessee SL makes the following entries to recognize the sale-leaseback transaction at

the time of sale (and leaseback commencement):


Cash 55,000

ROU asset1 21,000

PP&E (forklift) 30,000

Lease liability2 21,000

Financial liability3 5,000

Gain4 20,000

1 Equal to the lease liability (i.e., there are no adjusting items such as lease incentives, initial direct costs, or rent prepayments)

2 $26,000 present value of contractual leaseback payments – $5,000 off-market adjustment

3 The amount of the “off-market” adjustment: $55,000 sales price – $50,000 fair value of the forklift.

4 $50,000 adjusted sale price – $30,000 carrying amount of the forklift.


Implementation disclosures, and transition



Lessee presentation - Finance leases

Balance sheet

ROU assets

— Separate line-item; or

— Within another line

item, separate from

where operating lease

ROU assets are

presented

Lease liabilities



item, separate from

where operating lease

liabilities are presented

Income statement

ROU asset amortization

— Consistent with

presentation of

depreciation or

amortization of similar

assets

Interest expense on

lease liability

— Consistent with

presentation of other

interest expense

Statement of cash flows

Principal repayments

— Financing activities

Interest payments

— In accordance with

Topic 230 (typically, in

operating activities)

Variable lease payments

— Operating activities1

Presentation

1 Unless the payments represent costs to bring another asset into service.



Lessee presentation - Operating leases

Balance sheet

ROU assets



item, separate from

where finance lease

ROU assets are

presented

Lease liabilities



item, separate from

where finance lease

liabilities are presented

Income statement

Lease expense

— Included in lessee’s

income from continuing

operations (operating

expense)

Statement of cash flows

Lease payments

— Operating activities,

unless payments are

for costs to put another

asset in service

Variable lease payments

— Operating activities

Presentation



Lessor presentationPresentation

Balance sheet

— Present net investment in

the lease separately from

other assets on the face

of the balance sheet

— Disclose the components

of the net investment in

the lease (lease

receivable, unguaranteed

residual asset, and

deferred selling profit)

Income statement

— Lease income separately

presented or disclosed in

the notes

— Accretion of

unguaranteed residual

asset presented as

interest income

— Gross or net presentation

of profit (loss) at lease

commencement

depending on lessor’s

business model1

Statement of

cash flows

Operating

activities – all

cash inflows2

Lease type

Sales-type

and direct

financing

Operating — Continue to recognize

underlying asset in the

balance sheet

— Total lease income

recorded in a single line

item caption

— No recognition of interest

income

1 Direct financing leases are precluded from recognizing selling profit at lease commencement.2 Some direct financing lessors classify cash payments as investing activities under current GAAP. This will no longer be permitted.



DisclosuresDisclosures

Disclosure Objective: Enable financial statement users to assess the amount,

timing and uncertainty of cash flows arising from leases.

Lessees Lessors

— New qualitative and quantitative

disclosures to provide better

information to users.

— Lessees will exercise judgment to

determine the appropriate level at

which to aggregate, or disaggregate,

disclosures.

— New disclosures principally about

exposure to residual asset risk.



Example - Lessee quantitative disclosure

This table is an

example of how

the FASB

envisions a

lessee might

satisfy the

quantitative

disclosures

requirements.

However, the

FASB has not

mandated use of

the tabular

presentation.

Disclosures

Year ending December 31,

20X9 20X8

Lease Cost

Finance lease cost:

Amortization of right-of-use assets $XXX $XXX

Interest on lease liabilities XXX XXX

Operating lease cost XXX XXX

Short-term lease cost XXX XXX

Variable lease cost XXX XXX

Sublease income (XXX) (XXX)

Total lease cost $XXX $XXX

Other Information

(Gains) and losses on sale and leaseback transactions, net $(XXX) $XXX

Cash paid for amounts included in the measurement of lease liabilities XXX XXX

Operating cash flows from finance leases XXX XXX

Operating cash flows from operating leases XXX XXX

Financing cash flows from finance leases XXX XXX

Right-of-use assets obtained in exchange for new finance lease liabilities XXX XXX

Right-of-use assets obtained in exchange for new operating lease

liabilities

XXX XXX

Weighted-average remaining lease term – finance leases XX Years XX Years

Weighted-average remaining lease term – operating leases XX Years XX Years

Weighted-average discount rate – finance leases XX% XX%

Weighted-average discount rate-operating leases XX% XX%



Effective datesTransition

• Interim and annual periods in fiscal years beginning after December 15, 2018

Public business entities, certain not-

for-profit entities, and certain employee

benefit plans

• Fiscal years beginning after December 15, 2019, and interim periods in fiscal years beginning one year later

All other entities

Early adoption permitted for all entities upon issuance



Transition overviewTransition

Transition approach — Apply a modified retrospective transition approach:

▪ Restate all comparative periods presented

▪ No revisions to the accounting for leases that

expired prior to date of initial application

Package of practical

expedients

(All or nothing)

— An entity may elect not to reassess:

▪ Whether expired or existing contracts contain

leases under the new definition of a lease;

▪ Lease classification for expired or existing

leases; and

▪ Whether previously capitalized initial direct

costs would qualify for capitalization under Topic

842.

Use of hindsight

(Elect on its own or

with the package of

practical expedients)

— Hindsight allowed when considering likelihood of

exercising lessee options to extend or terminate a

lease or purchase the underlying asset, and in

assessing impairment of ROUs

Transition approach

Package of practical

expedients

(All or nothing)

Use of hindsight

(Elect on its own or

with the package of

practical expedients)



Example – Operating lease with practical expedients (1 of 4) Transition

— Lessee Z is a public company with a calendar year-end adopting Topic 842 on the

mandatory effective date. The following table outlines the key terms of the lease to

which it will apply the transition provisions and an illustrative timeline.




Comparative period Comparative period Current period

Beginning of earliest

period presented (date

of initial application)

January 1, 2017 January 1, 2018

Date of adoption

January 1, 2019 December 31, 2019

Carrying amounts

(before transition adjustments)

Accrued rent liability: $ 600

Unamortized IDCs: 1,200




— Lessee Z’s incremental borrowing rate is 5% at January 1, 2017.

— Lessee Z undertakes the following accounting at January 1, 2017 (transition date):

— Assuming Lessee Z does not modify the lease or have to remeasure the lease on or

after the effective date (January 1, 2019), Lessee Z will subsequently measure the

lease liability at the PV of the remaining minimum rental payments for the remainder of

the lease term and subsequently measure the ROU asset in accordance with Method 1

or Method 2 outlined earlier.

Step Amounts

Dr. (Cr.)

Calculation

Recognize lease liability $ (91,242) Remaining minimum rental payments (25,000 for

Year 2 and 26,000 for each of Years 3–5)

discounted at 5.0%

Recognize ROU asset 91,842 Sum of lease liability recognized, (600) accrued

rent liability, and 1,200 of unamortized IDCs

Derecognize accrued rent

liability

600 Balance at transition date under current U.S.

GAAP (see prior slide)

Derecognize unamortized

initial direct costs (IDCs)

(1,200) Balance at transition date under current U.S.

GAAP (see prior slide)

Adjustment to equity $ -- No adjustment to opening equity




— Lessee Z recognizes the following amounts in its annual balance sheets through the

end of the lease term:

— Lessee Z recognizes the following amounts in its income statements through the end of

the lease term:

Year ended ROU asset Lease liability

December 31, 2018 $ 48,144 $ 48,344

December 31, 2019 24,661 24,761

December 31, 2020 - -

Year ended ROU asset Calculation

December 31, 2017 $ 25,900 $128,000 total minimum

rental payments / 5 years

($25,600) + $1,500 in

IDCs/ 5 ($300)

December 31, 2018 25,900

December 31, 2019 25,900

December 31, 2020 25,900



Transition implementation issues*Date to which

“hindsight” extends

― Election of hindsight refers to “fresh look” at all relevant economic

factors as of the effective date.

― Hindsight does not extend to new events, actions, or changes in

circumstances that arise after the effective date.

Definition of ‘minimum

rental payments’

― Diversity in application under current US GAAP with respect to

inclusion or exclusion of “executory costs” (e.g. in gross leases).

― Should lease liability for Topic 840 operating leases based on the

remaining ‘minimum rental payments’ include or exclude such

amounts?

― Might either approach be acceptable based on current US GAAP

diversity?

Determining the

incremental borrowing

rate for existing

operating leases

― Should the rate determined at the transition date be based on the (1)

total payments and total lease term or (2) remaining payments and

remaining lease term?

Foreign exchange rate

used to translate the

operating lease right-

of-use assets

― Should the transition date ROU asset for an operating lease be

translated at the current FX rate or the FX rate at lease inception?

▪ Note: a finance lease ROU asset will continue to be translated at the same

FX rate used to translate the capital lease asset prior to transition.

Lease classification if

package of practical

expedients not elected

― Should an entity reassess lease classification under Topic 842 as of

the transition date (e.g. based on remaining economic life and asset’s

fair value as of that date) or as of the lease commencement date?

* Examples, not all-inclusive! Entities should continue to monitor additional developments, including from FASB and

SEC.



Staying informed— KPMG’s Leases Handbook

— Defining Issues® No. 16-6, FASB Balloons Balance Sheet with New Lease

Accounting Standard

— Executive Accounting Update – Lessees

— Executive Accounting Update – Lessors

— KPMG’s CFO Financial Forum Webcast: Overview of the FASB’s New Lease

Accounting Standard (March 7, 2016 – playback available)

— Replays of KPMG’s CFO Financial Forum Webcast – 4-part Series:

Staying informed

Part I –

Lease identification,

components, and key

definitions

Part II –

Lessee accounting

and transition

Part III –

Lessor accounting

and transition

Part IV –

Sale-leaseback

transactions,

build-to-suit

arrangements, and

other select topics

Visit: KPMG’s Financial Reporting View Leases Page

https://frv.kpmg.us/all-topics/leases.html

https://frv.kpmg.us/all-topics/leases.html

asc topic 842 leasesthe fasb issued its new lease accounting standard on february 25, 2016 (asu...

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