Kimber Bascom, Kyle Elken, Shawn Halladay 2016-11-15 06:34:13
CHANGES resulting from the new lease accounting standard (ASC Topic 842) may result in significant costs (some obvious, some subtle) for lessors and lessees. To mitigate the impact, planning should commence now. This article focuses on considerations associated with the accounting for lease and non-lease components of a contract.
Managed solution transactions, AKA bundled leases, are becoming increasingly common in the market as more customers shift to consumption models. Growing customer demand is creating opportunities for lessors, particularly captives, to blend low margin equipment with traditionally higher margin deliverables such as maintenance, consumables and professional services. Although seamless in appearance to customers, lessors must parse these transactions into lease and non-lease components. This article focuses on the lessor accounting for these components.
Separating components of a contract
If a contract contains a lease, Topic 842 requires lessees and lessors to identify and separately account for the components of the contract. This accounting, summarized in the following steps, is generally different than the accounting that would result from combining the components.
STEP 1: Identify the separate lease components if more than one asset is being leased.
STEP 2: Identify any non-lease components— e. g., maintenance or operating services.
STEP 3: Measure the “consideration in the contract.”
STEP 4: Separate and allocate the consideration in the contract between the lease and non-lease components.
STEP 1: Identify the separate lease components.
If a contract includes the right to use more than one underlying asset, lease accounting (including lease classification) is applied to each “separate lease component.” A lease component may contain the right to use more than one underlying asset as illustrated by Figure 1.
FIGURE 1
The lease component evaluation focuses primarily on the level of integration, interrelation and/or interdependence between the rights of use conveyed under the contract. A right to use an underlying asset (i.e., a lease), or a bundle of such rights is a separate lease component if
the lessee can benefit from it either on its own or together with other resources that are readily available (i.e., the lessee already has them or can readily acquire or lease them); and
the lease (or bundle of leases) is not highly dependent on or highly interrelated with the other leases in the contract.
A lease is highly dependent on or highly interrelated with another lease if each significantly affects the other. For example, the lease of an aircraft engine and the lease of the airframe that the engines are attached to each significantly affects the other. Conversely, the lease of an aircraft and the lease of a fuel truck do not significantly affect each other.
FIGURE 2
STEP 2: Identify any non-lease components
In addition to lease components, a contract may transfer other goods or services (i.e., non-lease components) to the lessee (e.g., when the lessor agrees to provide maintenance for a machine that it leases to a lessee). In that case the consideration in the contract is allocated between the lease and nonlease components.
An element of a contract is not a “component” if it does not transfer a separate good or service to the lessee (See Figure 2).
Payments associated with elements of a contract that are not components are part of the consideration allocated between the lease and non-lease components.
STEP 3: Measure the consideration in the contract.
Lessees and lessors measure the consideration in the contract to be allocated between lease and non-lease components differently. Once the amount of consideration has been measured, it is allocated to the lease and non-lease components of the contract.
LESSEE
To determine the consideration in the contract, lessees adjust the defined payments relating to the use of the underlying asset as shown in Figure 3.
LESSOR
As a starting point, a lessor measures the consideration in the contract in the same way as a lessee. However, further adjustments are made as shown in Figure 4.
If the contract requires payments that vary solely based on performance of the non-lease component(s), the lessor estimates those payments in part 1 of the calculation. In part 2 of the calculation, the lessor reduces those payments to the level for which it is probable that the lessee will be required to make them (as required by Topic 606).
STEP 4: Separate and allocate consideration between lease and non-lease components.
Lessors must separate non-lease components from lease components. Lease components are accounted for under Topic 842; non-lease components are accounted for under other applicable US GAAP (e.g., Topic 606).
FIGURE 3
FIGURE 4
FIGURE 5
The consideration in the contract is allocated between the lease and non-lease components of a contract as shown in Figure 5.
Lessors must consider all information that is reasonably available when estimating a stand-alone selling price—e.g., market conditions, entityspecific factors and information about the lessee. Lessors also must maximize the use of observable inputs and apply consistent methods to estimate the stand-alone selling price of components with similar characteristics.
Example
Lessee and Lessor enter into a 2.5-year lease of office equipment that includes maintenance services for the equipment throughout the contract term. Lessee will make annual payments of $400. Lessor normally leases the same equipment for $375 per year and offers a maintenance contract for $50 per year.
Topic 842 requires Lessor to allocate the consideration in the contract to the lease and non-lease components based on their relative standalone selling prices, as shown in Figure 6.
FIGURE 6
Kimber Bascom is Partner at KPMG LLP; Kyle Elken is U.S. Controller at DLL; and Shawn Halladay is Managing Director at The Alta Group. All are members of the ELFA Financial Accounting Committee.
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