Financial Reporting Quick Hits: (P)Lease Help! Understanding and Preparing for the New Lease Standard – February 2016
Dixon Hughes Goodman
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APPENDIX C | An Example of Lease Classification by a Lessor
This appendix provides an example of how a lessor would analyze a lease contract using the new lease classification assessment
in the new lease standard.
EXAMPLE
Facts:
Conclusion:
BT Rentals Co. enters into a lease agreement to rent a moving
truck to MoversRUs for a period of four years. The remaining
useful life of the truck at lease commencement is 5 years
and its current carrying amount is $35,000. The estimated
residual value of the truck is $5,000.
BT Rentals’ lease agreement with MoversRUs covers 80%
of the remaining useful life of the moving truck.
Furthermore, the present value of the anticipated lease payments, which BT Rentals has assessed as probable of being collected, amounts to substantially all of the fair value of the moving truck. Based on these facts, BT Rentals concludes that the lease should be classified as a sales-type lease with upfront profit recognition. Under the lease BT Rentals will receive from MoversRUs annual payments (occurring at the end of each period) in accordance with the following payment schedule: Year Amount 1 $10,000 2 $12,000 3 $14,000 4 $16,000 Total As a result, BT Rentals records the following entries at lease commencement: $52,000 Net investment in sales-type lease Cost of goods sold* Sales revenue** Moving truck $43,500 31,628 $40,128 35,000 * Calculated as the carrying amount of the moving truck less the present value of the estimated unguaranteed residual value. Based on BT Rentals’ analysis of the relevant facts and circumstances, BT Rentals concludes that collectability of the lease payments from MoversRUs is probable. ** Calculated as the present value of the future lease payments BT Rentals determines that the rate implicit in the lease is 10.35%. The present value of the lease payments is $40,128. For simplicity, assume that there are no initial direct costs or residual value guarantees provided to the lessor. 1. The formal effective date for public companies is annual reporting periods beginning after December 15, 2018, and interim periods therein.
Private companies are granted a one-year deferral. However, both public and private companies may elect to early adopt the standard. 2. This paper does not cover the changes made by the International Accounting Standards Board (IASB) to its lease accounting guidance. On January 13, 2016, the IASB issued International Financial Reporting Standard (IFRS) 16, which amends the accounting for leases for companies complying with IFRSs.
While IFRS 16 and the FASB’s new lease standard both require leases to be recorded on the balance sheet, significant differences remain between the two standards. 3. Refer to ASC 842-10-20. 4. Lease payments exclude contingent rental payments (e.g., rent based on percent of sales). 5. The rate implicit in the lease is the rate that causes the present value of the net investment in the lease to equal the sum of 1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized by the lessor and 2) any capitalized initial direct costs incurred by the lessor. If a lessee cannot readily determine the rate implicit in the lease, it would use its incremental borrowing rate as the discount rate. In addition, private companies will have the option to use the risk-free rate in calculating the present value of lease payments. 6. With respect to possible regulatory capital implications, from informal discussions with the FASB staff, we understand the FASB intentionally remained silent on the nature of the ROU asset in the final standard so as to avoid any negative impacts of classifying such assets as intangible assets. 7. Refer to ASC 842-10-55-26. 8. Refer to ASC 842-10-55-2. 9. Under the new lease standard the straight-line basis is used “unless another systematic and rational basis is more representative of the pattern in which benefit is expected to be derived from the right to use the underlying asset” (ASC 842-20-35-7). 10. Refer to ASU 2014-09, Revenue from Contracts with Customers. 11. Refer to ASC 606-10-05-4. 12. Refer to ASC 842-10-25-2 through 25-3 and ASC 842-30-25-3. 13. Refer to ASC 842-20-50-1 and ASC 842-30-50-1. 14. As explained in the new lease standard, the incremental borrowing rate is “[t]he rate of interest that a lessee would have to pay to borrow over a similar term and with a similar security the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.” Assurance | Tax | Advisory | dhgllp.com 13 .
Furthermore, the present value of the anticipated lease payments, which BT Rentals has assessed as probable of being collected, amounts to substantially all of the fair value of the moving truck. Based on these facts, BT Rentals concludes that the lease should be classified as a sales-type lease with upfront profit recognition. Under the lease BT Rentals will receive from MoversRUs annual payments (occurring at the end of each period) in accordance with the following payment schedule: Year Amount 1 $10,000 2 $12,000 3 $14,000 4 $16,000 Total As a result, BT Rentals records the following entries at lease commencement: $52,000 Net investment in sales-type lease Cost of goods sold* Sales revenue** Moving truck $43,500 31,628 $40,128 35,000 * Calculated as the carrying amount of the moving truck less the present value of the estimated unguaranteed residual value. Based on BT Rentals’ analysis of the relevant facts and circumstances, BT Rentals concludes that collectability of the lease payments from MoversRUs is probable. ** Calculated as the present value of the future lease payments BT Rentals determines that the rate implicit in the lease is 10.35%. The present value of the lease payments is $40,128. For simplicity, assume that there are no initial direct costs or residual value guarantees provided to the lessor. 1. The formal effective date for public companies is annual reporting periods beginning after December 15, 2018, and interim periods therein.
Private companies are granted a one-year deferral. However, both public and private companies may elect to early adopt the standard. 2. This paper does not cover the changes made by the International Accounting Standards Board (IASB) to its lease accounting guidance. On January 13, 2016, the IASB issued International Financial Reporting Standard (IFRS) 16, which amends the accounting for leases for companies complying with IFRSs.
While IFRS 16 and the FASB’s new lease standard both require leases to be recorded on the balance sheet, significant differences remain between the two standards. 3. Refer to ASC 842-10-20. 4. Lease payments exclude contingent rental payments (e.g., rent based on percent of sales). 5. The rate implicit in the lease is the rate that causes the present value of the net investment in the lease to equal the sum of 1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized by the lessor and 2) any capitalized initial direct costs incurred by the lessor. If a lessee cannot readily determine the rate implicit in the lease, it would use its incremental borrowing rate as the discount rate. In addition, private companies will have the option to use the risk-free rate in calculating the present value of lease payments. 6. With respect to possible regulatory capital implications, from informal discussions with the FASB staff, we understand the FASB intentionally remained silent on the nature of the ROU asset in the final standard so as to avoid any negative impacts of classifying such assets as intangible assets. 7. Refer to ASC 842-10-55-26. 8. Refer to ASC 842-10-55-2. 9. Under the new lease standard the straight-line basis is used “unless another systematic and rational basis is more representative of the pattern in which benefit is expected to be derived from the right to use the underlying asset” (ASC 842-20-35-7). 10. Refer to ASU 2014-09, Revenue from Contracts with Customers. 11. Refer to ASC 606-10-05-4. 12. Refer to ASC 842-10-25-2 through 25-3 and ASC 842-30-25-3. 13. Refer to ASC 842-20-50-1 and ASC 842-30-50-1. 14. As explained in the new lease standard, the incremental borrowing rate is “[t]he rate of interest that a lessee would have to pay to borrow over a similar term and with a similar security the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.” Assurance | Tax | Advisory | dhgllp.com 13 .
