Lease accounting implementation issues
No. US2017-02
August 11, 2017 (revised
September 12, 2017)
Background ................... 1
Scope………………………….2
Accounting for leases.....7
Modification and
remeasurement of a
lease………………………….14
Sale and leaseback
transactions………………15
Build-to-suit
transactions ................. 16
Business combinations –
leveraged leases .......... 17
Related party leases .... 17
Presentation ................ 18
Transition .................... 19
What’s next .................. 27
How to think about some frequently asked questions in the
new leases standard
At a glance
The FASB’s new standard on leases was issued in February 2016 and will be effective
for public business entities beginning in 2019. Because implementation efforts are
expected to be significant, especially for lessees, some entities are already working
through their implementation plans. As these entities sift through the details of the
new standard and think about how it should be applied to their arrangements, certain
issues have been raised. This publication highlights some frequently raised questions in
order to assist entities as they transition to the new standard.
For a comprehensive overview of the new standard and its related impacts, see PwC’s
accounting guide, Leases and In depth US2016-02.
Note: Questions 45 (a), 45 (b) and 45 (c) of this In transition have been
updated to reflect the most recent thinking on this matter.
Background
The FASB’s new standard, Leases (ASC 842), represents the first comprehensive
overhaul of lease accounting since FAS 13 was issued in 1976. There are elements of the
new standard that could impact almost all entities to some extent, although lessees will
likely see the most significant changes.
ASC 842 requires all lessees to reflect a lease liability and a right-of-use asset on their
balance sheet for all leases with a term of more than one year. A lessee’s income
statement recognition of lease-related expense will depend on the classification of the
lease as either an operating or finance lease. Although the pattern of expense recognition
may be similar to today’s accounting, the amount of lease expense recorded could differ
due to changes in how certain elements of rent payments are treated and the impairment
of the right-of-use asset.
The accounting model for lessors is similar to existing US GAAP, but certain changes
have been made to align it with the lessee accounting model and the new revenue
recognition standard. These changes could significantly change how lessors account for
certain leases, especially those with variable payments and third-party residual value
guarantees.
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The new standard is effective for public business entities for fiscal years, and interim periods within those fiscal years,
beginning after December 15, 2018. For all other entities, the new standard is effective for fiscal years beginning after
December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is
permitted for all entities.
The new standard is required to be adopted using a modified retrospective approach, which means application of the
new guidance at the beginning of the earliest comparative period presented in the year of adoption. To reduce some of
the burden of adoption, there are practical expedients available, some of which are required to be adopted together.
Certain implementation issues have been raised as companies are starting to work through the application of the new
guidance. While the FASB has indicated that it does not intend to establish a Transition Resource Group to address
potential implementation issues, it has had meetings to discuss some of these issues. This publication provides PwC’s
perspectives on some of the more frequently raised questions and issues in order to assist entities in their transition to
the new standard.
While we do not anticipate any significant standard setting to address these issues, it is possible that views may change
as a result of ongoing discussions among standard setters, regulators, preparers, and accounting firms.
Scope
Definition of a lease
Regardless of how an arrangement is structured, lease accounting guidance applies to any arrangement that conveys
control over the use of an identified asset to another party. An arrangement is a lease or contains a lease if an
underlying asset is explicitly or implicitly identified and the right of use of the asset is controlled by the customer for a
period of time in exchange for consideration.
Identified asset
An arrangement does not contain an identified asset if the supplier has a substantive right to substitute such asset. A
substitution right is substantive if (a) the supplier can practically use another asset to fulfil the arrangement throughout
the term of the arrangement, and (b) it is economically beneficial for the supplier to do so. The supplier’s right or
obligation to substitute an asset for repairs, maintenance, malfunction, or technical upgrade does not preclude the
customer from having the right to use an identified asset.
A capacity or other portion of an asset is an identified asset if it is physically distinct (e.g., a floor of a building or a
segment of a pipeline that connects a single customer to the larger pipeline) and the supplier does not have a
substantive substitution right. However, a capacity or other portion of an asset that is not physically distinct (e.g., a
capacity portion of a fiber-optic cable) is not an identified asset unless (1) it represents substantially all of the capacity of
the asset, thus providing the customer with the right to obtain substantially all of the economic benefits from the use of
the asset, and (2) the supplier does not have a substantive substitution right.
Right to control use of the identified asset
A customer controls the use of the identified asset by possessing the right to (1) obtain substantially all of the economic
benefits from the use of such asset (“economics” criterion); and (2) direct the use of the identified asset throughout the
period of use (“power” criterion). A customer meets the “power” criterion if it holds the right to direct how and for what
purpose the asset is used throughout the period of use. If the relevant decisions about how and for what purpose the
asset is used are predetermined, the customer must either have the right to operate or direct others to operate the asset
or must have designed the asset or specific aspects of the asset that predetermines how and for what purpose the asset
will be used throughout the period of use for the “power” criterion to be met.
PwC observation:
Under current lessee guidance, embedded leases are often off-balance-sheet operating leases and, as such,
application of lease accounting may not have had a material impact. Determining whether to apply lease accounting
to an arrangement under the new guidance is likely to be more important since virtually all leases will result in
recognition of a right-of-use asset and lease liability by the lessee on its balance sheet.
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The new embedded lease model differs in certain respects from today’s model. Given the differences from current GAAP
and the heightened importance of identifying leases, several questions have arisen in this area. Some of the frequently
asked questions are discussed below.
Question 1: Should an easement contract (i.e., a legal right to use another's land for a specific limited purpose) be
evaluated under the new leases guidance to determine if such an arrangement is or contains a lease?
Discussion: We believe that entities should evaluate any arrangement that contains an easement using the criteria in
the new leases standard for the purpose of determining whether the arrangement is or contains a lease.
The new leases standard defines a lease as a contract that conveys the right to control the use of identified property,
plant, or equipment for a period of time in exchange for consideration. There is a view that perpetual easements may
not meet the definition of a lease because there is no defined period of use. However, under this view, an entity must
consider if the easement is truly perpetual. For example, consider a “pay as you go” easement that provides the right to
use the land indefinitely. The perpetual provision may not be substantive if the easement holder can terminate at any
time by merely stopping the payments. Also, very long dated easements, such as a 99-year arrangement or longer are
not truly perpetual.
Term easements may or may not be leases depending on the nature of the easement. For example, based on facts and
circumstances at the inception date of the arrangement, if the easement is on land that is not used for any other
purpose, it is likely the easement contract would be a lease because the holder of easement rights has the right to obtain
substantially all of the economic benefits from that land. On the other hand, if the easement is on land that is also being
used for other purposes at the inception date of the arrangement, the holder of easement rights may not have the right
to substantially all of the benefits from the land and therefore the arrangement may not be a lease. In making this
assessment, conclusions around the appropriate unit of account (surface, sub-surface space, etc.) may be required.
Given the diversity in practice in applying the accounting model for easements under current GAAP (i.e., intangibles
guidance under ASC 350 versus leases guidance under ASC 840), the FASB at its meeting on May 10, 2017 directed the
staff to gather more information from stakeholders, auditors, and users about easements to help decide whether or not
additional standard setting in this area is warranted. At its meeting on August 2 nd, based on the results of its outreach,
the FASB decided the following:
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All land easements entered into on or after the effective date of the new leases standard would have to be
analyzed under the new leases standard to determine whether they are leases.
Existing land easements would be subject to the entity's existing accounting policy for such transactions,
i.e., intangibles guidance under ASC 350 or leases guidance under ASC 840.
Any changes in the historical accounting policy for land easements existing before the effective date of the new
leases standard would be considered a change in accounting policy under ASC 250, Accounting for Changes
and Error Corrections.
A technical correction will be made to Example 10 in the intangibles guidance (ASC 360-30) to eliminate
diversity in practice.
Question 2: Does a contract that permits a customer to use a lateral pipeline contain a lease of that lateral pipeline?
Discussion: It depends. A lateral pipeline is one that branches off the mainline pipeline to connect with or service a
specific customer or group of customers. We do not believe that a lateral pipeline is always controlled by the customer.
Therefore, a contract that permits a customer to use a lateral pipeline does not always contain a lease. The
determination of whether the customer controls the lateral pipeline typically depends on (a) whether it is operated on a
"closed or open valve" system, and (b) the functional independence of the lateral pipeline from the mainline pipeline. A
valve is a mechanical device installed in a pipeline that is used to control the flow of gas or liquid. If the lateral pipeline
has a closed valve, the customer has the ability to prevent product from flowing through it and thus can control the
compression in the lateral pipeline. In this circumstance, the customer controls the lateral pipeline and obtains
substantially all of the economic benefits from it; therefore, the contract contains a lease of the lateral pipeline. On the
other hand, if the main pipeline operator is using the lateral pipeline to manage compression throughout the entire
system, we believe the customer does not control the lateral pipeline and the arrangement does not contain a lease.
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Question 3: Can a customer have a lease of the “last mile” of a contiguous asset?
Discussion: It depends. In many pipeline arrangements, there is a portion of the pipeline that only goes to a specific
customer or group of customers. This is commonly called the “last mile.” If the “last mile” of a contiguous asset cannot
be mechanically separated (e.g., with a valve), we do not believe that the “last mile” is a physically distinct asset. If the
“last mile” can be mechanically separated, such as with a valve, it would be assessed similar to the discussion on lateral
pipelines in question 2.
Question 4: Does a contract that gives a customer the right to use a specific space on a cell tower that the supplier
cannot substitute contain a lease of that specific space?
Discussion: Yes. A cell tower is primarily constructed to sell or rent space on the tower to cell carriers, which is the
primary use of the cell tower. Therefore, the specific hosting locations on the cell tower are physically distinct and the
cell carrier has exclusive use of that specific hosting spot during the term of the arrangement. Thus, the unit of account
is the specific hosting spot.
The arrangement contains a lease of the hosting spot because (a) without a substitution right, the hosting spot is
identified; and (b) the cell carrier controls the use of the identified hosting spot because (1) it obtains all of the economic
benefits from its exclusive use; and (2) directs how and for what purpose the identified hosting spot is used throughout
the period of use by making all of the relevant decisions.
Question 5: If solar panels are installed on a rooftop, is the supplier of solar panels leasing the roof from the owner of
the building?
Discussion: It depends. The roof is a structural part of the building that serves to protect the inside of the building and
provides the owner with some economic benefit in that regard. However we believe the rooftop of a building is similar
to a floor inside a building. The space is identified because the owner of the building often does not have the practical
ability to substitute the space because of the need to place the solar panels in a particular location to take maximum
advantage of the sun. If the supplier of solar panels also obtains substantially all of the economic benefits from the
identified space and directs the use of that identified space because the supplier determines how the space will be used
(e.g., the supplier installed the solar panels in the space in a particular way), we believe such an arrangement contains a
lease of the rooftop space similar to a rooftop bar or restaurant. However, the conclusion may be different if the building
owner is leasing the solar panels from the supplier of solar panels.
Question 6: Does a contract that gives a customer the exclusive right to advertise on a specified billboard or a taxi tent
contain a lease?
Discussion: Yes. The primary use of a single-purpose advertising space, such as a billboard or a taxi tent, is to provide
space for advertisements. In other words, all of the economic benefits derived from the space come from advertising.
Therefore, if a customer has the exclusive right to use that space, we believe the customer has a lease of that particular
space because (a) there is an identified asset (there are no substitution rights) and (b) the customer controls the use of
the identified asset because the customer is taking all of the economic benefits from the use of that billboard/taxi tent
and directing the use of billboard/taxi tent by determining what advertisement will be displayed on the space.
Question 7: Does a contract that gives a customer the right to use a kiosk in the mall contain a lease of the kiosk?
Discussion: It depends on whether the mall owner has substantive substitution rights. If the mall owner cannot
substitute the kiosk with another or would not benefit from the substitution, then the contract would contain a lease
because the kiosk is an identified asset and the customer obtains substantially all of the economic benefits and directs
the use of the kiosk. If the mall owner has a substantive substitution right, there would not be a lease.
Question 8: Does a television cable service agreement contain a lease of the set-top box that is provided to the
customer?
Discussion: Generally yes. Most television cable service agreements provide the customer with a set-top box to use
during the contract period. In certain instances, depending on the level of functionality of the set-top box, we believe
that these agreements contain a lease of the set-top box because (a) there is an identified asset (it would not be
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economically beneficial for the television cable company to substitute the set-top box unless it was not working
properly); and (b) the customer controls how and for what purpose the set-top box is used (because the customer
determines when the set-top box is operated, in which rooms the box is used, and among the channels provided by the
television cable company, what channel it is set to). Further, we believe the customer obtains substantially all of the
economic benefits from the set-top box because the primary use of the set top box is to provide the customer with
entertainment and the customer obtains all of those benefits. Additionally, the supplier’s ability to track usage data from
the box and monetize such data is unrelated to the physical usage of the asset and consequently we do not believe it
would be considered an economic benefit from the use of the set-top box.
Question 9: Do supply arrangements involving exclusive use of a dedicated manufacturing line when dispatch rights
(i.e., the right to control the output at a given time) are controlled by the customer contain a lease?
Discussion: It depends on the specific facts and circumstances of the arrangement. For example, assuming the supplier
does not have a substantive substitution right and cannot use the manufacturing line for other purposes, if the ordering
process is in substance a dispatch right, we believe the arrangement would contain a lease since the customer is making
the relevant decisions that impact how and for what purpose the asset is used. This is because (a) the customer would
get substantially all of the economic benefit from the exclusive use of the identified manufacturing line, and (b) the
customer would have the ability to determine when, whether, and how often the line would be used. However, if the
ordering process is not in substance a dispatch right, the customer may be merely ordering product and the
arrangement would not contain a lease because the customer would not be making relevant decisions that impact how
and for what purpose the asset is used.
Utilizing capitalization thresholds
In the Basis for Conclusions for the new leases standard, the FASB observed that similar to accounting policies in other
areas of GAAP, entities may be able to establish reasonable capitalization thresholds below which assets and liabilities
related to a lease are not recognized.
Question 10: When establishing an appropriate capitalization threshold, does a lessee have to consider the impact to
disclosures or is consideration limited to the impact on the financial statements?
Discussion: We believe an entity should evaluate all relevant quantitative and qualitative factors impacting both the
financial statements and the footnote disclosures, including quantitative information about a lessee’s lease costs. This
could result in a lower capitalization threshold than would be determined based on the financial statement effects alone.
Note that the new leases standard requires several quantitative disclosures.
Question 11: Is it appropriate for a lessee to net the right-of-use asset and lease liability when establishing the
capitalization threshold?
Discussion: No. We believe all financial statement line items should be evaluated individually and in the aggregate
when establishing an appropriate threshold.
Separating lease and nonlease components
Companies often enter into a variety of arrangements that are leases (or may contain embedded leases). Such
arrangements may have both lease and nonlease components. The components must be properly identified as they are
subject to different accounting models.
Components are those items or activities that transfer a good or service to the lessee. The right to use an underlying
asset is a separate lease component if (1) the lessee can benefit from the right of use of the underlying asset either on its
own or together with other resources that are readily available, and (2) the right of use of the underlying asset is neither
highly dependent on nor highly interrelated with other rights to use underlying assets in the arrangement.
Property taxes and insurance are not considered components because they do not involve the delivery of a good or
service. They will be incurred by the owner of the underlying asset whether or not the underlying asset is leased.
Maintenance costs, on the other hand, involve delivery of a separate service, and are therefore considered a nonlease
component if provided by the lessor to the lessee.
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Land is a separate lease component unless the accounting effect of treating land separately would be insignificant (e.g.,
the amount recognized for the land lease component would be insignificant or separating the land lease component
would not impact the lease classification of any lease component).
Once the lease and nonlease components are identified, contract consideration is allocated to each component. A lessee
should allocate the contract consideration to the separate lease and nonlease components based on their relative
standalone prices. As a practical expedient, a lessee may, as an accounting policy election by class of underlying asset,
choose to not separate nonlease components from the associated lease component and instead account for them as a
single lease component.
A lessor should allocate contract consideration to the separate lease and nonlease components in accordance with the
transaction price allocation guidance in ASC 606, Revenue from Contracts with Customers. The practical expedient
available to a lessee for lease and nonlease components is not available to a lessor.
Question 12: Should a lessee include property taxes and insurance-related payments made directly by the lessee for the
leased asset in the computation of contract consideration to be allocated to the components of the contract?
Discussion: It depends. Payments for property taxes and insurance when a lessor is the primary beneficiary of the
insurance policy would be incurred by a lessor regardless of whether or not the asset was leased. If a lessee is required
to incur payments for property taxes and insurance, it does not matter whether the lessee directly pays a third-party on
the lessor’s behalf or reimburses the lessor. We believe inclusion of payments made by a lessee for property taxes and
insurance in contract consideration will depend on whether the lessee is required to pay a fixed amount or a variable
amount. If a lessee is required to pay a fixed amount of property taxes and insurance, such payments should be included
in contract consideration and allocated to the lease and nonlease components by both the lessee and lessor. If a lessee is
required to pay the actual amount for property taxes and insurance, i.e., a variable amount rather than fixed payments,
such payments should be accounted for similar to other variable lease payments that do not depend on an index or a
rate. That is, they should be excluded from contract consideration and should instead be recorded as incurred by the
lessee and earned by the lessor.
Question 13: If a lessee pays for real estate taxes and insurance on behalf of the lessor, should the lessor gross up the
income statement for real estate taxes and insurance payments (i.e., present lease income and expense for real estate
taxes and insurance separately on the income statement)?
Discussion: Yes. We believe the lessor should present lease income and expense for real estate taxes and insurance
separately when the lessee pays for these expenses on behalf of the lessor because these costs are the lessor’s cost of
owning the leased asset. The lessor may need to get the payment information from the lessee in order to do this.
Question 14: Would a lessee in a multi-tenant building need to consider if there is a land lease component in its
contract?
Discussion: Yes. One of the requirements for an arrangement to be or contain a lease under the new leases standard is
for the underlying asset to be identified. If the underlying asset is not physically distinct, it is an identified asset only if it
represents substantially all of the capacity of the asset and the supplier does not have the substantive right to substitute
such asset.
While the land on which a building is located is physically distinct, a tenant in a multi-tenant building has the right to
use a non-physically distinct portion of that land. Therefore, we believe a tenant’s right to use a non-physically distinct
portion of the land would be an identified asset if such right is for substantially all of the capacity of the land. For
example, if the tenant was leasing 9 floors of a 10 story building, it would be reasonable to conclude that the right to use
the land in the arrangement is an identified asset. The arrangement would then contain a land lease component
provided the other criteria for a lease were met.
Once the tenant determines that the arrangement contains a land lease component, the tenant should account for the
right to use the land as a separate lease component unless the accounting effect of doing so would be insignificant (that
is, if separating the land component would have no effect on lease classification of any other lease component or the
amount recognized for the land lease component would be insignificant).
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Accounting for leases
Variable lease payments
The new leases standard defines variable lease payments as “payments made by a lessee to a lessor for the right to use
an underlying asset that vary because of changes in facts or circumstances occurring after the commencement date,
other than the passage of time.” Any payments that vary based on an index or a rate should initially be measured using
the index or rate at the commencement date. Variable lease payments other than those that vary based on an index or a
rate should not be included in lease payments for purposes of classification and measurement of the lease, unless those
payments are in substance fixed lease payments. The following example addresses questions about whether rents based
on fair market rents should be accounted for similar to index or rate-based rents.
Facts: A lessee enters into a five-year non-cancellable office lease. The lease contains a 5-year renewal option that the
lessee is reasonably certain to exercise. The lease payments are fixed at $600K annually for each of the first five years.
The annual lease payments for the renewal option will be set at the beginning of the renewal period based upon the fair
market rent at the beginning of the renewal period.
Question 15: Should the lease liability include amounts related to the renewal period even though the amount of the
annual lease payments for that period is unknown at the lease commencement date?
Discussion: The new leases standard does not specifically address this issue. There are two potential ways in which such
variable lease payments could be considered:
(a) Include the fair market rent during the renewal period when calculating the lease liability at lease
commencement because such rents are akin to variable lease payments that depend on an index or rate.
(b) Exclude the fair market rent during the renewal period in lease payments when calculating the lease liability at
lease commencement because such rents are not based on an index or rate.
We believe it is appropriate to treat the variable lease payments that will be based on fair market rent similar to variable
lease payments that depend on an index or rate (view (a)). This approach is consistent with paragraph 28 of IFRS 16,
Leases, which says that variable lease payments that depend on an index or rate include payments that vary to reflect
changes in market rental rates.
Subsequent to the lease commencement date, when the actual payments in the renewal period are known, the lessee
would not remeasure the lease payments. Rather, any changes would be a period cost during the period in which they
are incurred. The lessor would record the changes as earned during the period they occur.
Discount rate
Incremental borrowing rate
The new leases standard requires a lessee to use the rate implicit in the lease. If that rate is not available, the lessee’s
incremental borrowing rate should be used. The definition of incremental borrowing rate has changed under the new
leases standard:
Current guidance (ASC 840)
The rate that, at lease inception, the lessee would have incurred to borrow over a similar term the funds necessary to
purchase the leased asset. This definition does not proscribe the lessee's use of a secured borrowing rate as its
incremental borrowing rate if that rate is determinable, reasonable, and consistent with the financing that would have
been used in the particular circumstances.
New guidance (ASC 842)
The rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount
equal to the lease payments in a similar economic environment.
The following example addresses questions about how the change in the definition impacts how a lessee should
determine such rate.
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Facts: A lessee leases a building for five years and will pay $100,000 in rent at the end of each year (i.e., $500,000 total
lease payments). The fair value of the building is $4,000,000. Standard borrowing practices permit a 70% loan-to-value
ratio on similar financings to purchase the building.
Question 16(a): Could the lessee use the building as collateral when determining the incremental borrowing rate?
Discussion: No. We believe that the lessee cannot use the building as collateral because the lessee does not own the
building and therefore does not have the right to pledge the building. The lessee could use its leasehold interest in the
building if a lender would accept that as collateral and if it would be enough collateral to borrow the $500,000 total
lease payments. We believe that any form of collateral can be used to determine the incremental borrowing rate, so long
as it is a fully-secured rate for a loan with a similar term as the lease. In other words, the collateral does not have to be
related to the leased asset. For example, an observable interest rate for an existing secured line could be an acceptable
incremental borrowing rate.
Question 16(b): Is the lessee limited by the 70% loan-to-value ratio?
Discussion: Under the current leases guidance, the incremental borrowing rate is defined as that rate the lessee would
have incurred to borrow, over a term similar to the lease term, the funds necessary to purchase the leased asset. If the
lessee historically utilized a secured and unsecured funding source, assuming a 70% loan-to-value ratio, the incremental
borrowing rate would normally be a weighted average of 70% secured borrowing with the building as collateral and 30%
unsecured borrowing. The loan-to-value ratio would be relevant under the new leases standard if the collateral was
limited to the right-of-use asset. However, since we believe the standard permits the use of any collateral for
determining the incremental borrowing rate, it would be reasonable to assume the loan should be 100% collateralized.
Thus, the loan-to-value ratio is irrelevant under the new leases standard.
Lease incentives
Lessors often make payments to or on behalf of the lessee as an incentive for the lessee to enter into a lease. The
incentives may be in the form of reimbursement for certain costs incurred by the lessee, such as moving costs or
leasehold improvements. Incentives may be structured in many different ways. For example, they may be fixed or a
variable amount subject to a cap, paid to the lessee upfront or over time. The following example addresses certain
questions raised in connection with lease incentives.
Facts: A landlord and tenant enter into a building lease. The landlord agrees to reimburse the tenant for leasehold
improvements considered as lessee assets subject to a cap. Any unused incentive balance remaining at the first
anniversary of the lease commencement date will expire. It is reasonably certain the tenant will use the entire amount
available for reimbursement by the landlord for leasehold improvements within a year from the lease commencement
date.
Question 17(a): Should the lease incentive be considered fixed or variable at the lease commencement date?
Discussion: Since it is unlikely that a tenant would forgo any incentive from the landlord, we believe the tenant should
treat the incentive in this fact pattern as an "in substance fixed payment" from the landlord to the tenant.
Question 17(b): If the lease incentive is considered fixed, how should the incentive be recognized initially?
Discussion: If the incentive is considered fixed, we believe the tenant should estimate the timing of receipt of the
payment at lease commencement when calculating the lease liability, which in turn would get reflected in the
calculation of the right-of-use asset.
Question 17(c): If the lease incentive is considered fixed, how should a change in the timing of receipt of the payment be
recognized?
Discussion: Subsequent to the commencement date, there are two ways in which any variability in the timing of the
receipt of the incentive could be considered by the tenant.
(a) Account for the variability as a period adjustment via the income statement.
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(b)
Analogize to the remeasurement guidance for a lessee anhed remeasure the lease liability (and hence
the right-of use asset) using the same discount rate used at the lease commencement date.
We believe option (b) is appropriate.
Question 17(d): If the facts in this example were changed such that the lease incentive was considered variable, how
should it be recognized?
Discussion: If the incentive was considered variable, we believe the tenant would account for the incentive as a period
item when received from the landlord.
PwC observation:
Lessees will need to establish processes and controls for projecting the expected receipt of incentives and to monitor
any changes in the expected timing to ensure any variability is accounted for in the proper period.
Lease term
Determining the lease term in a head lease and a sublease
Under the new leases guidance, the lease term is the noncancellable term of the lease together with consideration of,
among other things, periods covered by an option to extend (or not to terminate) the lease when exercise of the option is
controlled by the lessor. The following example addresses questions about how to determine the lease term when there
is a sublease.
Facts: A lessee leases an asset for a 20-year noncancellable period with two 5-year renewal options (the “head lease”).
The lessee subleases the leased asset also for a noncancellable period of 20 years with two 5-year renewal options. The
lessee in the head lease (as sublessor) determines the sublessee is not reasonably certain to exercise its options to
extend the sublease. The lessee also determines it is not reasonably certain that it will exercise any renewal options in
the head lease.
Question 18: How should the lessee (sublessor) determine the term of the head lease?
Discussion: There are two ways in which a lessee (sublessor) could determine the term of the head lease:
(a) The definition of lease term only requires options controlled by the lessor to be included in the lease term.
Therefore, in the example, the term of the head lease would be 20 years because the lessor cannot control if the
lessee will exercise the extension option.
(b) The definition of the lease term establishes a principle that renewal options that are outside the lessee’s control
should be included in the lease term. Therefore, the head lease term would be 30 years, since the lessee (as
sublessor) cannot avoid a liability imposed on it by its sublessee should the sublessee exercise its right to extend
the sublease. This is notwithstanding the sublease term may be 20 years since the lessee (as sublessor) may
conclude that the sublessee is not reasonable assured of exercising the extension option.
At its meeting on November 30, 2016, the FASB agreed with view (a). The board also decided that in accordance with
the lessor guidance on reassessment, the lessee (as sublessor) should not reassess whether the sublessee is reasonably
certain to renew the sublease. It would only need to determine the impact when the sublessee actually exercises the
renewal option.
Initial recognition and measurement – lessor
Substantial variable payments
It is common for suppliers in certain industries to structure transactions with significant variable payments. Suppliers
in these industries are willing to accept variability in payments because they believe such arrangements would be
profitable overall and high variable payments can make an arrangement attractive to the customer.
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There are instances when transactions with significant variable payments may qualify as a transfer of control to the
customer under the new revenue recognition standard. Such transactions may also qualify as a sales-type lease under
the new leases guidance. This is because the new revenue standard (ASC 606) says that the transfer of title is only one of
the indicators for control being transferred to a customer.
Whether a transaction with variable payments is subject to the revenue guidance or the leases guidance may impact
when revenue is recognized by a supplier. Under the new leases standard, variable payments that do not depend on an
index or rate are not considered until the contingency is resolved. Under the new revenue recognition standard, variable
payments may be recognized as revenue upfront (when earned) provided certain conditions are met.
We believe that when a transaction with significant variable payments qualifies as both a sale under the new revenue
recognition standard and a lease under the new leases standard, the leases standard should be applied. Under the lease
classification criteria in the new leases standard, it is possible for lease arrangements with significant variable lease
payments to be classified by lessors as a sales-type lease. This may lead to the recognition of an initial loss by the lessor
even if the overall arrangement is expected to be profitable. This is a change in the timing and pattern of recognition
compared to the current leases guidance, under which lessors generally recognize leases with significant variable
payments as operating leases.
At its meeting on November 30, 2016, the FASB discussed the issue of a “day 1” loss for a sales-type lease with
significant variable payments and decided not to make a change to the guidance in the new leases standard. The
following example illustrates a “day 1” loss in a sales-type lease with significant variable lease payments.
Facts: A supplier will install an X-ray machine at a hospital’s (customer’s) premises and maintain it for a period of five
years. The supplier can substitute the X-ray machine only in the event of malfunction, which is expected to be
infrequent. The customer will decide in which department the X-ray machine will be used and the hours of its
operation. The customer’s employees will operate the machine. The customer will be responsible for providing all of the
consumables needed (e.g., X-rays films, chemicals). The customer will bear the risk of loss in the event of damage or
theft and will be responsible for purchasing insurance to protect against physical loss of the machine. As is customary in
this industry, the supplier does not intend to repossess the machine at the end of the term. Consequently, the customer
may decide to continue to use the machine or scrap it after the five-year period. The supply of X-ray machines is part of
the supplier’s ongoing major or central operations. The transaction qualifies as a sales-type lease. Other facts of the
arrangement are:
Term of the arrangement
5 years (noncancellable)
Remaining economic life of the X-ray
machine
5 years
Payments from the customer
$5/click of the X-ray machine to take an
X-ray
Fixed maintenance fee of $2,000/year
for 5 years (payable at the end of each
month)
Variable payments estimate during the
term of the arrangement
$125,000
Fair value of the X-ray machine
$100,000
Supplier’s carrying value of the X-ray
machine at commencement
$80,000
Estimated fair value of the X-ray machine
at the end of 5 years
$0
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Standalone price for leasing a similar Xray machine for 5 years
$100,000
Standalone price for maintenance for 5
years
$10,000
Inception date and commencement date
January 1
Other
Collection of payments from the
customer is probable
Question 19(a): How should the supplier (lessor) account for this transaction at the lease commencement date?
Discussion: The arrangement contains two components - a lease component (the lease of the X-ray machine) and a
nonlease component (the maintenance services).
Contract consideration is $10,000 ($2,000*5), which is the fixed amount for maintenance over the 5 years. Contract
consideration excludes the $5/click because it relates to the lease component and is a variable payment that does not
depend on an index or a rate. Therefore, the supplier (lessor) would allocate the contract consideration between the
components under the new leases guidance as follows:
Component
Lease
Maintenance
Total
Standalone
price
(A)
Allocation %
(A/$110,000)
(B)
Allocation of contract
consideration
(B*$10,000)
$100,000
90.91%
$9,091
$10,000
9.09%
$909
$110,000
100%
$10,000
At lease commencement, the supplier (lessor) would record the following journal entries:
Dr. Lease receivable
Dr. Cost of goods sold
Cr. Inventory
Cr. Revenue
$9,091
$80,000
$80,000
$9,091
The $70,909 loss at the commencement of the lease ($80,000 - $9,091) occurs due to the exclusion of variable
payments from contract consideration.
Question 19(b): Would it be appropriate for a lessor to use a negative discount rate to avoid recording a day-1 loss in
arrangements where there are significant variable payments?
Discussion: No. At its meeting on November 30, 2016, the FASB confirmed that they did not intend for the rate implicit
in a lease to be less than zero.
Land leases
The new leases standard requires a lessor in a sales-type lease or direct financing lease to measure the net investment in
the lease at lease commencement as the sum of the present value of (a) the lease receivable and (b) the unguaranteed
residual asset. The standard defines lease receivable and unguaranteed residual asset as follows:
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Lease Receivable
A lessor’s right to receive lease payments arising from a sales-type lease or a direct financing lease plus any amount that
a lessor expects to derive from the underlying asset following the end of the lease term to the extent that it is guaranteed
by the lessee or any other third party unrelated to the lessor, measured on a discounted basis.
Unguaranteed Residual Asset
The amount that a lessor expects to derive from the underlying asset following the end of the lease term that is not
guaranteed by the lessee or any other third party unrelated to the lessor, measured on a discounted basis.
It is unclear whether the estimated residual value should be limited to the lease commencement date fair value, which is
discussed in question 20.
Question 20: For a long-term land lease that is determined to be a sales-type or a direct financing lease for a lessor,
should the estimated residual value be limited to the lease commencement date fair value of the land?
Discussion: Under the current leases guidance, long standing practice has been that a lessor’s estimate of the residual
value of leased property should not exceed the fair value of the leased property at lease inception. However, a literal
read of the definitions of “lease receivable” and “unguaranteed residual asset” in the new leases standard may suggest
that it is appropriate to not limit the estimated residual value to the underlying asset’s fair value at lease
commencement. This interpretation would result in the recognition of estimated future increases in the value of the
asset at the commencement date of the lease. We do not believe this would be an appropriate result. Consequently, we
believe current practice should continue and the estimated residual value of leased property, including land, should not
exceed its fair value at lease commencement.
Recognition of step rents
Lease arrangements may have uneven or stepped rents. Excerpted below is the paragraph from the Basis for
Conclusions for the new leases standard in connection with step or uneven rents.
BC327. Although in the Board’s view, recognizing rental income on a straight-line basis often will reflect the
pattern in which income is earned from the underlying asset, it noted, consistent with previous GAAP, that this
will not always be the case. For example, the Board concluded that it would be simpler and more consistent with
its proposals on variable lease payments to recognize lease income arising from variable lease payments for
operating leases in the period in which the changes in facts and circumstances on which the payments are based
occur, rather than on a straight-line basis. Consequently, the Board decided that a lessor should recognize rental
income on a systematic basis that is not straight line if that basis was more representative of the pattern in which
income is earned from the underlying asset. Nonetheless, a lessor is expected to recognize uneven fixed lease
payments on a straight-line basis when the payments are uneven for reasons other than to reflect or compensate
for market rentals or market conditions (for example, when there is significant frontloading or backloading of
payments or when rent-free periods exist in a lease).
Question 21: May a lessor recognize uneven rents on other than a straight line basis if the rents are designed to reflect
estimated future market rents?
Discussion: No. We understand there was no intent to change current practice in this area.
Subsequent recognition and measurement – lessee
Impairment of the right-of-use asset
Under the new leases standard, a right-of-use asset is subject to the impairment guidance in ASC 360, Property, Plant,
and Equipment. Certain questions have arisen regarding the application of the impairment guidance to a right-of-use
asset in an operating lease. This could be significant because the impairment of a right-of-use asset in an operating lease
will cause the lessee to lose straight-line rent expense recognition in its income statement. The lease expense will
continue to be reported as a single line item but will become “front-end loaded,” similar to a finance lease.
Question 22: What is the measurement model for impairment for an asset group that contains an operating lease?
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Discussion: Currently, a lessee’s operating leases are off-balance sheet. Therefore, when a lessee tests an asset group
that contains an operating lease for impairment under ASC 360, the lessee includes the entire rent payment as an
outflow in the undiscounted cash flow recoverability test. However, under the new leases model, an operating lease will
typically get reflected on the lessee’s balance sheet as a right-of-use asset and a lease liability. Thus, the lessee will need
to determine whether the interest portion of operating lease payments should be included as a cash outflow in
determining the undiscounted cash flows when assessing the asset group for impairment using the recoverability test in
ASC 360. The following approaches can be considered:
(a) Include the operating leases payments as a cash outflow in the calculation of undiscounted cash flows. This
approach is similar to the current model for testing asset groups for impairment under ASC 360 that have
associated operating leases.
(b) Exclude the interest portion of operating lease payments from the cash outflow in the calculation of
undiscounted cash flows. This approach is similar to the current model for capital leases being tested for
impairment as part of an asset group.
At its meeting held on November 30, 2016, the FASB observed that either approach would be a reasonable application
of the standard.
Subsequent recognition and measurement – lessor
Impairment of net investment in the lease
Under the new leases standard, a lessor is required to evaluate its net investment in the lease using the guidance
applicable for receivables in ASC 310, Receivables, and upon its adoption, the guidance in ASC 326, Financial
Instruments - Credit Losses. The Basis for Conclusions in the new leases standard says that that even though the
unguaranteed residual asset component of the net investment in the lease does not meet the definition of a financial
asset, for the sake of simplicity, it should not be separately assessed for impairment. Therefore, the entire net
investment balance should be assessed for impairment under the guidance applicable to receivables.
The new leases guidance further states that when determining the loss allowance for a lease receivable, a lessor should
consider the collateral relating to the net investment in the lease, which includes cash flows the lessor expects to derive
from the underlying asset during the remaining lease term, but excludes such cash flows following the end of the lease
term.
Question 23: Should a lessor include cash flows from the residual value of the underlying asset when evaluating its net
investment in a lease for impairment?
Discussion: We believe that the answer is yes.
The unit of account for impairment purposes is the lessor’s net investment in the lease, which is made up of the lease
receivable from the lessee and the unguaranteed residual at the end of the lease term less any deferred profit. Thus, the
risk associated with the net investment in the lease is (a) the risk associated with the cash flows from the lease; and (b)
the risk associated with the cash flows from the residual asset at the expiration of the lease term.
The guidance only addresses the risk associated with the lease receivable, i.e., cash flows from the lease and the
collateral available to the lessor to alleviate that risk when determining the loss allowance for the lease receivable. The
only asset that is available to the lessee is its right to use the leased asset during the lease term. The lessee has no right
over the residual asset. Therefore, when evaluating the loss allowance for the lease receivable portion of the net
investment in the lease, the lessor can only consider the lessee’s right to use the asset during the lease term as collateral
for the lease receivable and not the right to the residual asset. Therefore, in order to properly evaluate the impairment of
the net investment in the lease, we believe that the cash flows derived from the unguaranteed residual value of the
underlying asset following the end of the lease term should be included in the impairment assessment in addition to the
cash flows from the lease.
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Modification and remeasurement of a lease
Lease remeasurement - lessee
The new leases standard requires a lessee to remeasure a lease based on the occurrence of triggering events that are
under the control of the lessee. A reassessment event occurs, for example, when (i) there is a significant change in facts
and circumstances in the control of the lessee that directly affects whether a renewal, purchase, or termination option is
reasonably certain of exercise (e.g., a lessee constructs significant leasehold improvements during the lease term such
that exercise of a renewal option is reasonably certain) or (ii) the lessee simply elects to exercise a renewal option that
was not previously included in the lease term. Upon the occurrence of a reassessment event, a lessee is required to
reassess the lease classification. The new leases standard is not explicit about whether the underlying assumptions
should be updated when reassessing the lease classification in these cases.
Question 24: When reassessing lease classification upon a reassessment event, should the lessee update the underlying
assumptions (e.g., fair value of the underlying asset) for purposes of reassessing lease classification?
Discussion: The new standard is explicit that upon a modification event (e.g., the amount of the lease payments are
changed or the parties negotiate an extension), the lessee should update the underlying assumptions when assessing the
lease classification at the effective date of a contract modification that is not accounted for as a separate contract.
However, there is no explicit guidance about whether the underlying assumptions should be updated when reassessing
the lease classification upon the occurrence of a reassessment event.
We believe the accounting for a reassessment event (e.g., an exercise of a renewal option or when exercise of an option
becomes reasonably certain) should be the same as the accounting for a negotiated extension (i.e., a contract
modification). Therefore, the underlying assumptions for purposes of reassessing lease classification should be updated
upon a reassessment event.
Reduction in scope of a lease - lessee
A modification or reassessment of a lease may result in a partial termination of the lease. Examples of events that result
in a partial termination include terminating the right to use one or more underlying assets and decreasing the leased
space.
In the event of a partial termination, the lease liability and right-of use asset should be adjusted. The right-of-use asset
should be decreased in proportion to the partial termination of the existing lease. The difference between the
proportionate decrease in the carrying amount of the right-of-use asset and the decrease in the carrying amount of the
lease liability resulting from the modification should be recorded in net income.
The new leases standard provides two ways to determine the proportionate reduction in the right-of-use asset. It can be
based either on the reduction to the right of use or on the reduction to the lease liability. For example, if a lessee
decreases the amount of space it is leasing in an office building by 45% and as a result, the lease liability decreases by
50%, the right-of-use asset could be decreased by either 45% or 50%. The method used will impact the calculated gain
or loss.
Question 25: Can either method be applied on a transaction by transaction basis or should it be applied consistently by
electing an accounting policy by class of underlying asset or for all leases?
Discussion: Although the leases standard does not address this question, we believe a lessee should treat its selected
method as an accounting policy election by class of underlying asset. The policy should be applied consistently to all
modifications that decrease the scope of a lease.
Remeasurement based on an increase in a rate or an index - lessee
It is common for a lease to contain payments that are based on a rate or an index, e.g., the Consumer Price Index (CPI).
In an example in the new leases guidance (i.e., example 25), the lease liability is not remeasured based on an increase in
lease payments due to an increase in CPI. However, the standard also requires a lessee to remeasure its lease liability if
a contingency upon which some or all of the future variable lease payments are based is resolved such that those
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payments now meet the definition of lease payments (ASC 842-10-35-4(b)). A question has arisen in connection with
the potentially conflicting guidance.
Question 26: Should a lessee remeasure a lease liability when payments increase (but do not decrease) with changes in
CPI (i.e., the increase creates a new floor for lease payments)?
Discussion: Based on the explicit guidance in example 25 of the new leases standard, we believe a lessee should not
remeasure a lease liability when payments increase based on a change in CPI.
We believe the guidance in ASC 842-10-35-4(b) is applicable to variable payments not based on an index or rate.
Accordingly, even though the change in lease payments from a change in CPI results in a new floor for lease payments
prospectively, we believe the liability should not be remeasured in these cases. If, however, the lessee had to remeasure
lease payments for other reasons (e.g., a reassessment of the lease term or a modification to the lease), the lessee should
use the current floor in lease payments (i.e., escalated by previous changes in CPI) for purposes of remeasurement.
Sale and leaseback transactions
The new leases standard introduces a new model for sale and leaseback transactions applicable to both lessees and
lessors. A sale and leaseback transaction will qualify as a sale only if:
(a) There is a contract and control has transferred per the guidance in the new revenue recognition standard;
(b) The leaseback is not a finance lease; and
(c) A repurchase option, if any, is exercisable at a price that is the asset’s fair value at the time of exercise and a
substantially similar alternative asset is readily available in the marketplace.
When these conditions are met, control has passed to the buyer-lessor and the buyer-lessor should recognize a
purchase. The seller-lessee should derecognize the underlying asset and recognize a gain or loss on sale as appropriate.
Recognition of a gain (adjusted for off-market terms) immediately upon the recognition of the sale and leaseback
transaction is a change from today’s guidance, under which typically the gain is deferred and recognized over the lease
term.
If the transaction does not qualify as a sale, the seller-lessee would not derecognize the transferred asset and would
reflect the proceeds from the sale and leaseback transaction as a borrowing. The buyer-lessor would reflect its cash
payment as a loan to the seller-lessee.
Question 27: Does a repurchase option (at any exercise price) held by a seller-lessee on real estate subject to a sale and
leaseback transaction always preclude the seller and purchaser from accounting for the transaction as a sale and
purchase, respectively?
Discussion: Yes. We believe a seller-lessee repurchase option (at any exercise price) on real estate subject to a sale and
leaseback transaction always precludes the seller and the purchaser from accounting for the transaction as a sale and
purchase, respectively.
Under the new leases guidance, if a seller-lessee holds a repurchase option on the asset subject to sale and leaseback,
assuming all other conditions are met, the transaction will qualify for sale and purchase by the seller-lessee and the
buyer-lessor, respectively, if (a) the exercise price of the repurchase option is at fair value at the time such option is
exercised, and (b) there are alternative assets, substantially the same as the transferred asset, readily available in the
marketplace. In the new standard’s Basis for Conclusions, the FASB observed that real estate assets would not meet
criterion (b) because real estate is, by nature, unique. Therefore, no other real estate asset could be substantially the
same as the transferred asset.
We believe the above guidance also applies to integral equipment. ASC 978, Real Estate — Time-Sharing Activities,
defines integral equipment as any physical structure or equipment attached to the real estate that cannot be removed
and used separately without incurring significant cost.
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PwC observation:
Sale and leaseback transactions involving equipment often include a fixed price purchase option for the seller-lessee to
repurchase the equipment at the expiration of the lease term. This provision does not result in a failed sale under
current guidance unless the option is a bargain repurchase option. However, arrangements with a fixed price
repurchase options will not qualify as a sale under the new leases standard.
Build-to-suit transactions
When a prospective lessee is involved in the construction or design of an underlying asset prior to lease commencement
(commonly referred to as a “build-to-suit” arrangement), current US GAAP imposes prescriptive qualitative and
quantitative rules that often result in the lessee being considered the owner of the asset during construction for
accounting purposes. In such case, the lessee is required to record debt equal to construction funding provided by the
landlord to construct the asset.
The new leases standard replaces today’s build-to-suit guidance with a new model under which a lessee is deemed to be
the owner of an asset under construction only if the lessee controls the asset during the construction period. Control can
be obtained in a variety of ways. Judgment will be required in assessing control.
If a lessee controls the asset during construction, the lessee and lessor would need to apply the sale and leaseback model
to determine whether the arrangement qualifies for sale and leaseback accounting or a financing arrangement.
Question 28: The new leases standard considers the lessee to be the owner of the asset during the construction period if
the lessee has the right to obtain the partially constructed asset “at any point during the construction period.” Does “at
any point during the construction period” mean a lessee must have the right to obtain the asset at all times during the
construction period or at some point during the construction period?
Discussion: We believe the lessee would be considered the owner of the asset during the construction period if the
lessee has the right to obtain the partially constructed asset at some point during the construction period. If the lessee
does not have the right at all times, ownership of the asset would be imputed at the point in time that the lessee has the
right to obtain the partially constructed asset (e.g., when a purchase option becomes exercisable).
There may be circumstances in which the purchase option becomes exercisable only upon contingent events occurring,
such as when the lessee or the lessor is in default. In these cases, we believe the lessee would generally be considered to
have the right to obtain the partially constructed asset if the contingent event were within the control of the lessee. All
facts and circumstances should be considered carefully. For example, a lease that provides a lessee the right to acquire
the partially constructed asset if the lessee was in default may be considered within the control of the lessee. However, a
lessee default under the lease contract may result in economic consequences to the lessee, such as triggering cross
defaults in the lessee’s other arrangements. The right to acquire the partially constructed asset in this circumstance may
not be considered substantive.
If the lessee is considered the owner of the asset during the construction period, we believe the lessee would recognize
the construction in progress as an asset and any lessor funding of construction as a liability. Sale and leaseback
accounting would be applied at construction completion.
Question 29: How should lessor put options be assessed when determining whether the lessee controls the asset under
construction?
Discussion: The new leases standard provides a list of circumstances in which the lessee would be considered to control
the underlying asset being constructed before the lease commencement date. In these cases, the lessee would be
considered the owner of the asset during the construction period and would apply sale and leaseback accounting at
construction completion.
While the new leases standard notes that a purchase option held by the lessee may provide the lessee control of the asset
during construction, it also notes that the list of circumstances provided is not all inclusive. Thus, there may be other
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circumstances that individually or in combination demonstrate that a lessee controls an underlying asset that is under
construction before the commencement date.
We believe a put option held by the lessor to put the asset under construction to the lessee should be assessed to
determine whether the lessor has a significant economic incentive to exercise its put right consistent with the guidance
regarding repurchase agreements in the new revenue standard. If an incentive exists, the lessee would be assumed to
control the construction in process and would be considered the owner of the asset during the construction period. For
further guidance, refer to PwC’s accounting guide, Revenue from contracts with customers — 2016 global edition,
Section 8.7.
Business combinations – leveraged leases
The new leases standard eliminates leveraged lease accounting for new leases on or after the effective date. However,
existing leveraged leases that commenced before the effective date of the new standard and are not modified on or after
the effective date of the new standard are grandfathered.
Question 30: Should leveraged leases acquired in a business combination after the effective date retain their
grandfathered status absent a modification?
Discussion: The guidance in the new leases standard is unclear as to whether or not leveraged leases acquired in a
business combination are grandfathered. We believe that unmodified leveraged leases acquired in a business
combination after the effective date should continue to be accounted for as a leveraged lease. This view is:
●
●
●
Consistent with the Board’s intention;
Consistent with the guidance in the new leases standard that lease classification should be retained for
unmodified leases acquired in a business combination; and
Supported by the amendments to ASC 740, Income Taxes, which note an exception to the recognition of taxrelated assets and liabilities in a business combination related to leveraged leases accounted for under the
grandfathered guidance for leveraged leases in the new leases guidance.
Related-party leases
The new leases standard requires leases between related parties to be classified and measured in accordance with the
lease classification criteria applicable to all other leases on the basis of the “legally enforceable terms and conditions of
the lease” in the separate financial statements of the related parties. This differs from the current lease accounting
standard, which requires related-party leases to be recognized based on the economic substance rather than the legal
form of the transaction.
While intercompany leases would be eliminated for the purposes of consolidated reporting, some of the legal entities
may be required to prepare standalone financial statements. As a result, the application of the new lease accounting
model may impact a number of regulatory reporting and capital calculations for certain entities.
A typical example of an intercompany agreement is one in which an entity enters into an agreement with its parent
company, or another member of the consolidated group, under which the entity will pay a fee in return for the use of
space (e.g., a floor in the building), equipment, employees, and other services, such as maintenance. This agreement
may contain a lease. However, if the legally-enforceable term of such an agreement is 12 months or less, the lessee could
elect the short-term exemption by class of underlying asset permitted by the new leases standard and not reflect a rightof-use asset and a lease liability on its balance sheet.
Question 31: How should “legally enforceable” be interpreted in connection with related-party leases?
Discussion: The FASB acknowledged in the Basis for Conclusions for the new leases standard that some related-party
transactions are not documented and/or the terms and conditions are not at arm’s length. Therefore, in order to
operationalize the applicability of the short-term exemption, we believe a lessee should first focus on the written
agreement and determine the legally enforceable lease term based on the written agreement. If the economics of the
written agreement do not align with the economics of other transactions (e.g., the lease term is one year but the lessee is
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installing expensive leasehold improvements that have an economic life of greater than one year) or there is no written
agreement, the lessee should determine if there is an oral agreement or understanding.
The lessee should solicit input from legal counsel about whether the terms and conditions of the oral agreement or
understanding are legally enforceable and should analyze the applicability of the short-term exemption based on
legally-enforceable terms and conditions.
PwC observation:
Even though a lessee may elect, by class of underlying asset, not to reflect a right-of-use asset and a lease liability on
its balance sheet for leases with a term of 12 months or less, entities must apply the disclosure requirements for
related-party leases under ASC 850, Related Party Disclosures. This includes disclosing information necessary to
understand the effects of the related-party transactions on the entity's financial statements.
Presentation
No stated consideration for embedded leases
Certain service contracts that contain embedded leases may not have explicit consideration stated for the embedded
leases. For example, in order to enhance the services provided by a vendor to a customer, the customer may allow the
vendor the right to control a designated location on the customer’s property for the vendor to place its owned
equipment. If the arrangement for the designated location is considered a lease from the customer to the vendor, absent
any stated consideration, a question arises about whether such arrangements should be accounted for on a gross basis
or a net basis.
Question 32: Should arrangements that do not have a stated consideration for embedded leases be accounted for on a
gross basis (i.e., record additional revenue and expense for the “free” embedded leases), or can the revenue and expense
be netted in the income statement?
Discussion: We believe arrangements that do not have stated consideration for embedded leases should generally be
accounted for on a gross basis. Thus, a vendor should gross up its income statement for the “free” embedded lease. That
is, the vendor should recognize additional revenue for the sale of its products/services to a customer and expense for the
“free” embedded lease of the customer’s asset. Similarly, the customer should recognize additional income for the “free”
lease of its asset to the vendor offset by additional cost related to the purchase of the products/services from the vendor.
The parties to an arrangement should account for the multiple elements regardless of whether they are embedded in the
same contract for a net amount of consideration, or are separate contracts with designated amounts of consideration.
A gross up of the income statement is not appropriate in all situations. For example, assume a vendor places solar
panels on a customer’s roof and the customer is the exclusive user of the solar panels such that the arrangement is
considered a lease of the solar panels. In such an event, we believe as long as the vendor is not expected to ever obtain
control of the rooftop (i.e., the solar panel lease term is consistent with the overall term of the contract), there would not
be a lease of the rooftop.
Loss in a direct financing lease
A direct financing lease results in a loss if the present value of the lease payments and estimated residual value is less
than the lessor’s carrying value of the asset plus initial direct costs at lease commencement date. In these cases, the loss
would be recognized up front.
Question 33: Should a loss on a direct financing lease be recognized in the sales and cost of sales line items or as a net
loss in a single line item?
Discussion: We believe the loss should generally be recognized as a net loss in a single line item.
As discussed in paragraph BC96 in the Basis for Conclusions for the new leases standard, when a lease is not a salestype lease but meets the criteria to be classified as a direct financing lease, the lease transaction effectively converts the
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lessor’s risk arising from ownership of the underlying asset (that is, asset risk) into credit risk. However, if the lessor has
not transferred control to the lessee through a sales-type lease, we generally do not believe that sales and cost of sales
should be recognized.
Further, in paragraph BC98, the Board analogized a loss on a direct financing lease to an impairment loss. Thus, we
believe the loss should be recognized in a single loss line item akin to an impairment loss.
Transition
All entities adopting the new leases standard have the option to elect certain practical expedients intended to ease the
burden of transition. Questions have arisen in connection with implementation of these practical expedients.
Package of practical expedients
As of the effective date, an entity can elect the following practical expedients together as a package for all leases that
existed as of later of the beginning of the earliest period presented in the financial statements and the commencement
date of the lease (“initial application date”):



An entity need not reassess whether any contracts are or contain embedded leases at the initial application date.
An entity need not reassess the lease classification for any leases at the initial application date, e.g., leases that
were classified as operating leases or capital leases under the current leases guidance will be classified as
operating leases and finance leases, respectively, under the new leases guidance.
An entity need not reassess whether initial direct costs meet the new definition at the initial application date.
An additional practical expedient (discussed in the Hindsight section below) can be elected separately or in conjunction
with the above package of practical expedients.
Question 34: Does the new leases standard need to be applied to leases that exist as of the initial application date but
expire or terminate before the effective date?
Discussion: Based on the words in the standard, we believe leases that exist as of the initial application date and expire
or terminate before the effective date are subject to the new standard in an entity’s comparative financial statements as
of the effective date. For example, a calendar year-end public company adopting the new leases standard on 1/1/2019
should apply the new standard to a lease that existed on 1/1/2017 and expired in 2018.
Question 35: Is the new leases standard applicable to arrangements agreed to or committed to at or before the effective
date of EITF Issue No. 01-8, Determining whether an arrangement is a lease?
Discussion: EITF 01-8 provided guidance for determining whether an arrangement contains a lease under previous
GAAP. The transition provisions of EITF 01-8 explained that its provisions were effective for arrangements (a) agreed to
or committed to, (b) or modified, or (c) acquired in a business combination initiated after the beginning of an entity's
first reporting period beginning after May 28, 2003. As a result, arrangements at or before the effective date of EITF 018 were grandfathered and companies were not required to determine if such arrangements were or contained leases
under ASC 840, Leases.
The new leases standard does not address whether or not arrangements that were grandfathered under EITF 01-8
would continue to be grandfathered when an entity adopts the new leases standard. We believe an entity electing the
package of practical expedients would not be required to reassess whether arrangements grandfathered under EITF
01-8 are or contain leases. However, if an entity does not elect the package of practical expedients, we believe the entity
should assess all arrangements that were outstanding as of the initial application date to determine if they are or
contain leases under the new leases guidance, even if such arrangements were previously grandfathered under EITF
01-8.
Question 36: If an entity does not elect the package of practical expedients, should the entity reassess lease
classification under the new leases standard as of the lease commencement date or at the initial application date?
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Discussion: We believe an entity should reassess lease classification as of the commencement of the lease or the last
time the lease was required to be reassessed under ASC 840, for example, the lease modification date.
Hindsight
When adopting the new leases standard, an entity may elect to apply hindsight to leases that existed during the period
from the beginning of the earliest period presented in the financial statements until the effective date (the “lookback
period”). For example, for a calendar year-end public company, the lookback period would be 1/1/2017 through
12/31/2018. Upon election, the entity should apply hindsight to determine the lease term (i.e., consider the outcome of
lessee options to extend or terminate the lease and decisions to purchase the underlying asset) as well as assess the
impairment of right-of-use assets. This practical expedient can be elected separately or in conjunction with the package
of practical expedients and must be applied consistently to all leases during the lookback period.
Question 37: Does the election of hindsight by an entity require the entity to undertake a fresh assessment of the facts
and circumstances in the lookback period even if there have been no triggering events in such period?
Discussion: We believe an entity should undertake a fresh assessment of the facts and circumstances in the lookback
period when applying the hindsight practical expedient, taking into consideration all available information prior to the
effective date.
For example, assume a calendar year-end public company adopts the new leases standard on 1/1/2019 (so the lookback
period is 1/1/2017 through 12/31/2018). The entity has a lease that commenced prior to 1/1/2017 and the lessee
exercised an extension option on 1/1/2018. In this situation, we believe if the lessee elects hindsight at the time of
adoption on 1/1/2019, the lessee should recognize a lease liability and a right-of-use asset on 1/1/2017 assuming the
extended lease term.
Even if the lessee’s extension option was not exercisable in the lookback period (for example, if the extension option is
only exercisable on or after 1/1/2019) but it was reasonably certain that the lessee would exercise the extension option
at or after the effective date (i.e., 1/1/2019) because of a change in facts and circumstances from the original assessment
date, the lessee should recognize a lease liability and a right-of-use asset on 1/1/2017 assuming the extended lease term.
We believe hindsight extends only up until the effective date (e.g., 1/1/19 for a calendar year-end public company).
An entity should not apply the hindsight practical expedient when a contract is modified (for example, a modification to
extend the term of the lease when that renewal term was not already included in the original contract).
Lessee transition
A lessee should reassess classification of a lease under the new guidance if the lessee does not elect the package of
practical expedients. It is possible for leases previously classified as operating leases to be classified as finance leases
and previous capital leases to be classified as operating when transitioning to the new leases standard. For example, an
operating lease under ASC 840 could get classified as a finance lease under the new leases standard due to certain
executory costs getting allocated to the lease component or the discontinuance of the exemption from the present value
classification criterion if the lease commencement date falls at or near the end of the asset’s economic life. Another
example is a long-dated land lease that is classified as an operating lease under ASC 840 because there is no transfer of
ownership or a bargain purchase option. Such a lease could get classified as a finance lease under the new leases
standard if the present value classification criterion was met.
A change in lease classification could also occur if a lessee elects the hindsight practical expedient and does not elect the
package of practical expedients. For example, a lessee’s determination of lease term based on whether the lessee is
reasonably certain to exercise or not exercise options to extend or terminate the lease or to purchase the underlying
asset may be different in the lookback period from the lessee’s original assessment if the lessee elects hindsight at the
effective date.
Note that the election of the package of practical expedients or the hindsight practical expedient must be applied
consistently to all leases, both as a lessee or lessor.
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Question 38: What is the accounting for unamortized initial direct costs by a lessee at transition that do not meet the
new definition of initial direct costs in ASC 842 if the lessee elects the package of practical expedients?
Discussion: According to ASC 842-10-65-1(f), an entity that elects the package of practical expedients need not reassess
whether initial direct costs meet the new definition at the initial application date. However, according to ASC 842-1065-1(p), any unamortized initial direct costs at the initial application date that do not meet the new definition should be
written off as an adjustment to equity. Questions have arisen about the apparent conflict between these two provisions.
We believe if a lessee elects the package of expedients in ASC 842-10-65-1(f) for all leases as of the effective date, it does
not need to reassess whether initial direct costs meet the new definition at the initial application date. However, if the
lessee does not elect the package expedients in ASC 842-10-65-1(f), we believe any unamortized initial direct costs at the
initial application date that do not meet the new definition of initial direct costs in ASC 842 should be written off as an
adjustment to equity at the initial application date consistent with the guidance in ASC 842-10-65-1(p).
Question 39: What is the accounting for an operating lease that is modified during the lookback period if the lessee
elects the package of practical expedients upon adoption of the new leases standard?
Discussion: When a lessee elects the package of practical expedients upon adoption of the new leases standard, a lease
classified as an operating lease under ASC 840 would continue to be classified as an operating lease under ASC 842. The
transition provisions require application of a hybrid model under which the lessee would recognize a lease liability and a
right-of-use asset under ASC 842 for such a lease using the amounts calculated under ASC 840 at the initial application
date. The transition provisions in ASC 842 further prescribe that the lessee should apply the modification and
remeasurement guidance in ASC 842 should such a lease be modified after the lookback period. However, there is no
guidance that addresses when a lease is modified during the lookback period. In such a scenario, we believe a hybrid
model should be applied as follows:


The lessee should use the model for modifications in ASC 840 to determine the accounting for the modified
operating lease.
The lessee should use the guidance in ASC 842 to recognize the modification, i.e., measure payments based on
ASC 840 but use the guidance in ASC 842 to adjust the lease liability and the right-of-use asset.
Question 40: What is the accounting model when a capital lease under ASC 840 (classified as a finance lease under ASC
842) is modified during the lookback period?
Discussion: The new leases guidance requires the modification guidance under ASC 842 to be followed when a capital
lease under ASC 840 (classified as a finance lease under ASC 842) is modified after the lookback period. There is no
guidance when such a lease is modified during the lookback period. We believe the lessee should follow the modification
guidance in ASC 840 to account for a modification during the lookback period since there was no change in the lease
classification.
Question 41: Assume a lessee neither elects the package of practical expedients nor the hindsight practical expedient
upon adoption of the new leases standard. What is the accounting for a lease modification during the lookback period if
the classification of an operating or capital lease under ASC 840 changes under the new leases standard at the initial
application date?
Discussion: There is no guidance on the accounting if a lessee elects not to apply the package of practical expedients or
hindsight upon adoption of the new leases standard and an operating or capital lease under ASC 840 is classified
differently under ASC 842 and then modified during the lookback period. We believe the lessee should account for any
modification in this scenario under the modification model in ASC 842 irrespective of whether the modification took
place during or after the lookback period. We believe this approach is reasonable because the classification of the lease
changed upon adoption of the new leases standard.
Question 42: What is the transition accounting model for a lease previously classified as a capital lease under ASC 840
when a lessee elects the package of practical expedients as well as hindsight for purposes of adopting the new leases
standard?
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Discussion: ASC 842-10-65-1(r)(1) prescribes transition guidance for a lessee that has a capital lease under ASC 840
that is classified as a finance lease under ASC 842. Under this guidance, the basic model is that the lessee should
recognize a right-of-use asset and a leases liability at the carrying amount of the lease asset and the capital lease
obligation under ASC 840 at the initial application date. A literal application of this guidance may result in an
anomalous discount rate if a lessee that has a capital lease under ASC 840 elects both the package of practical
expedients and applies hindsight (to determine the lease term) when transitioning to ASC 842. The application of
hindsight could result in a shortened (or lengthened) lease term because exercise of a renewal option may no longer be
reasonably certain (or may have become reasonably certain). In this situation, the discount rate required to amortize
the carrying value of the capital lease obligation (determined under ASC 840) to zero by the end of the shortened (or
lengthened) lease term may get significantly reduced (or increased).
This issue could occur whenever a lessee elects the package of practical expedients as well as the application of
hindsight for its existing operating leases. In that case, the lessee would also need to apply the expedients to its existing
capital leases.
In circumstances when a literal application of ASC 842-10-65-1(r) would produce a materially distorted interest rate, we
believe a lessee may apply the following approach to transition existing capital leases:



Apply hindsight at the lease inception date to determine an appropriate discount rate.
Using such discount rate, recalculate the new capital lease asset and capital lease obligation balance (as well as
any deferred initial direct costs balance) under ASC 840 as of the initial application date as though the lease
term was always the updated lease term based on hindsight.
Any difference between the recalculated and existing balances at the initial application date should be recorded
as an adjustment to equity.
The lessee should then follow the transition accounting in ASC 842-10-65-1(r) through (t) using the recalculated
balances.
Question 43: Assume a lessee neither elects the package of practical expedients nor applies hindsight for purposes of
adopting the new leases standard. Also assume a lease that commenced prior to the lookback period classified as a
capital lease under ASC 840 is reclassified as an operating lease at the initial application date upon adoption of the new
standard. In this scenario, ASC 842-10-65-1(s) prescribes that the lessee derecognize the carrying value of the capital
lease asset and obligation and treat the difference between the two as prepaid or accrued rent. The guidance further
prescribes that the lessee should recognize a lease liability and a right-of-use asset. The right-of-use asset is equal to the
lease liability adjusted for items such as any prepaid or accrued lease payments under ASC 840. Should the prepaid or
accrued rent due to the difference between the carrying value of capital lease asset and obligation derecognized be
included in the calculation of the right-of-use asset at the initial application date?
Discussion: Yes. We believe the difference between the carrying value of capital lease asset and obligation derecognized
at the initial application date should be included in the measurement of the operating lease right-of-use asset.
Question 44: In transition, what is the impact of prior impairments under ASC 360, Property, Plant, and Equipment,
during the lookback period to an asset group including an operating lease right-of-use asset?
Discussion: The FASB clarified at its November 30, 2016 board meeting that it did not intend for lessees to adjust prior
period impairment measurements or allocations upon adoption of the new leases standard. If an asset group that
includes an operating lease had been impaired under current GAAP during the lookback period, an allocation of the
prior period asset group impairment should not be included in the measurement of the operating lease right-of-use
asset upon adoption of the new leases standard. Instead, a right-of-use asset for a lessee’s operating lease should be
assessed for impairment under current GAAP, for example, ASC 420, Exit or disposal cost obligations (if the entity has
ceased use of the leased asset), or ASC 840 (if the lessee subleased the underlying leased asset at a loss) during the
lookback period. The impairment provisions of ASC 360 would apply on or after the effective date.
Lease components
Under the new leases guidance, an entity is required to separate lease and nonlease components. However, a lessee
may, as an accounting policy election by class of underlying asset, choose to not separate nonlease components from the
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associated lease components and instead account for each separate lease component and its associated nonlease
components as a single lease component.
At transition, a lessee is required to measure a lease liability for leases classified as operating under current GAAP equal
to the sum of the present value of (1) the remaining minimum rental payments (as defined in ASC 840), and (2) any
amounts probable of being owed by the lessee under a residual value guarantee as defined under the new leases
standard.
Question 45(a): For purposes of calculating the lease liability at transition under the new leases guidance, can a lessee
make an accounting policy election to not separate lease and nonlease components in transition (i.e., during the
lookback period)?
Discussion: The term “minimum rental payments” is not defined in ASC 840 and the description of “minimum lease
payments” is unclear.
With respect to a lessee, current guidance says that minimum lease payments include minimum rental payments called
for by the lease over the lease term. It states that minimum lease payments comprise payments the lessee is obligated to
make in connection with the leased property. For purposes of the minimum lease payments classification test, executory
costs, such as insurance, maintenance, and taxes to be paid by the lessor are excluded. Based on this, one could imply
that minimum lease payments include executory costs, hence the need to require their specific exclusion for purposes of
the minimum lease payments classification test. Thus, it is unclear whether these executory costs should be included in
or excluded from minimum rental payments for transition purposes.
Since the current guidance is unclear, we believe a lessee in an operating gross lease (i.e., a lease that includes executory
costs in the fixed rent payments) may choose not to separate executory costs (property taxes, insurance, and
maintenance) from the lease component in transition.
With respect to nonlease components other than executory costs, we would not object to a lessee choosing to not
separate such components from the associated lease components at transition only if the lessee makes an accounting
policy election by class of underlying asset to not separate nonlease components from the associated lease components
on and after the effective date.
Question 45(b): If a lessee makes a policy election to not separate just the executory costs from the lease component in
transition, must the lessee continue to apply it going forward? Conversely, if a lessee elects a policy to separate all
nonlease components from the associated lease components in transition, would it be able to elect an accounting policy
to not separate nonlease components from the associated lease components for new leases entered into on or after the
effective date?
Discussion: In either of the scenarios described in this question, we believe the approach elected by a lessee for
transition purposes is independent of the policy election available to the lessee on or after the effective date.
Question 45(c): How does a lessee’s choice to separate or not separate the executory costs from the associated lease
component during transition impact subsequent accounting in the event of a reassessment trigger or a modification that
is not considered a new lease? Assume the lessee chooses to separate nonlease components other than executory costs
from the associated lease component during transition.
Discussion: We believe a lessee’s choice regarding which components to separate or not separate during transition
creates a unit of accounting that should be carried forward on and after the effective date. For example, assume a gross
lease has two nonlease components, maintenance (an executory cost) and ancillary services (not associated with
maintenance) provided by the lessor. If the lessee elected to not separate maintenance from the lease component in
transition, the two units of accounting established in transition (i.e., the lease component and the ancillary services
nonlease component) should remain consistent even in the event of a modification that is not a new lease or
remeasurement on or after the effective date. The units of accounting established at transition should be maintained
regardless of whether the lessee makes an accounting policy election to separate nonlease components from the
associated lease components for new leases commenced on or after the effective date.
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Lessor transition
A lessor should reassess classification of a lease under the new guidance if the lessor does not elect the package of
practical expedients. It is possible for leases previously classified as operating leases to be classified as sales-type leases
(STL) or direct financing leases (DFL) and previous sales-type leases/direct financing leases to be classified as operating
when transitioning to the new leases standard. For example, an operating lease under ASC 840 could get classified as a
sales-type lease under the new leases standard due to the discontinuance of the exemption from the present value
classification criterion if the lease commencement date falls at or near the end of the asset’s economic life.
A change in lease classification could also occur if a lessor elects the hindsight practical expedient and does not elect the
package of practical expedients. For example, a lessor’s determination of lease term based on whether the lessee is
reasonably certain to exercise or not exercise options to extend or terminate the lease or to purchase the underlying
asset may be different if the lessor elects hindsight at the effective date, which could cause a change in the classification.
The election of the package of practical expedients or the hindsight practical expedient must be applied consistently to
all leases, both when an entity is a lessee and when it is a lessor.
Leveraged leases are grandfathered under the new leases standard as long as the lease is not modified after the effective
date.
Question 46: Assume a lessor elects the package of practical expedients upon adoption of the new leases standard. What
is the accounting if an operating or sales-type or direct financing lease under ASC 840 is modified during the lookback
period?
Discussion: The transition provisions in ASC 842 do not provide any guidance on the accounting in this scenario. We
believe the lessor should follow the modification guidance in ASC 840 should there be a modification of the lease during
the lookback period. Modification guidance under the new leases standard should be followed for a modification after
the lookback period.
Allocation of contract consideration to revenue and lease components
Question 47: Is an entity required to reallocate contract consideration between revenue components and lease
components when adopting the new revenue recognition standard?
Discussion: This question arises in the context of an entity adopting the new revenue recognition standard before the
new leases standard.
If an entity adopts the new revenue standard and the new leases standard at the same time and also elects the package
of practical expedients in new leases standard, the entity is not required to reassess the accounting for lease
components, including the allocations between lease and nonlease components in contracts restated under the new
revenue standard. However, the transition guidance in the new revenue standard does not explicitly provide any relief
from this requirement if an entity adopts the new revenue standard before the new leases standard.
The FASB clarified at its meeting on June 21, 2017 that an entity should not reallocate contract consideration to lease
components within the scope of the existing leases guidance when the entity adopts the new revenue standard. The
FASB also observed that no further standard setting was needed in this regard.
Foreign currency
The transition guidance in the new leases standard does not address how to treat the effects of foreign exchange rates in
a lease that is denominated in a currency other than an entity’s functional currency. As a result, certain questions have
arisen.
Question 48: In transitioning to ASC 842, what exchange rate should be used to determine lease payments for purposes
of measuring a lessee’s operating lease liability and right-of use asset for existing operating leases or measuring a
lessor’s net investment in a lease for operating leases that get reclassified as sales-type or direct financing leases as of
the earliest period presented?
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Discussion: For leases that were classified as operating leases under ASC 840, a lessee should initially recognize a rightof-use asset and a lease liability at the earliest period presented in the financial statements (e.g., 1/1/17 for a calendar
year-end public company for an existing lease as of that date). There are two approaches to which exchange rate to use:
(a) Use the foreign exchange rate at the earliest period presented to determine lease payments for both the lease
liability and the right-of-use asset
(b) Use the foreign exchange rate at the lease commencement date to determine lease payments for the right-of-use
asset because the right-of-use asset is a non-monetary asset. Use the foreign exchange rate at the earliest period
presented to determine lease payments for the lease liability because a lease liability is a monetary liability. The
difference between the right-of-use asset and the lease liability would be recognized as an adjustment to
opening retained earnings.
We believe approach (a) is reasonable because the transition guidance in the new leases standard requires the right-ofuse asset to be initially equal to the lease liability adjusted for other items. This is accomplished by using the exchange
rate at the initial application date. In addition, ASC 830-20-30-1 states: “At the date a foreign currency transaction is
recognized, each asset, liability ... shall be measured initially in the functional currency of the recording entity by use of
the exchange rate in effect at that date.” Consequently, the lessee would use the foreign exchange rate in effect at the
date of initial recognition of the right-of-use asset and lease liability (for a calendar year-end public business entity, this
would be 1/1/2017 for an existing operating lease).
Similarly, we believe approach (a) is reasonable for a lessor to recognize a net investment in a lease at the earliest period
presented in the financial statements for existing operating leases that are reclassified as sales-type or direct financing
leases.
Question 49: How should foreign currency gains or losses for a lessee’s operating leases and a lessor’s operating leases
that get reclassified as sales-type or direct financing leases during the lookback period be accounted for after the initial
application date?
Discussion: The transition guidance in ASC 842-10-65-1(d) of the new leases standard states: “An entity shall adjust
equity at the beginning of the earliest comparative period presented, and the other comparative amounts disclosed for
each prior period presented in the financial statements, as if the pending content that links to this paragraph had always
been applied…”
Subsequent to the initial application date, based on the general transition guidance in ASC 842-10-65-1(d), the income
statements during the lookback period (i.e., 2017 and 2018 for a calendar year-end public company), should be recast to
reflect retrospectively the effect of foreign currency exchange rate movements on lease-related monetary assets and
liabilities.
Sale and leaseback
The transition guidance for sale and leaseback transactions in the new leases standard states that an entity should not
reassess whether the asset transferred would have been a sale under the new leases standard if a previous sale and
leaseback transaction qualified for sale-leaseback accounting under ASC 840.
If a previous sale and leaseback transaction failed to qualify for sale-leaseback accounting under ASC 840, and remains
a failed sale at the effective date, an entity should reassess whether a sale would have occurred at any point in the
lookback period under the new leases standard. If a sale would have been deemed to have occurred under the new
leases standard, the transaction should be accounted for on a modified retrospective basis from the deemed date of sale.
The transition guidance requires the leaseback to be accounted for under the applicable lessee and lessor transition
guidance during the lookback period.
Certain questions have arisen in connection with the transition of sale and leaseback transactions existing prior to the
effective date of the new leases standard.
Question 50: Must lessors apply sale and leaseback transition guidance under the new leases standard to failed sale and
leaseback transactions under ASC 840 that existed prior to the effective date of the new leases standard?
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Discussion: The transition provisions require that transactions that “failed” sale-leaseback accounting under ASC 840
through the effective date be reassessed under the new leases standard to determine if they would qualify as a sale
during the lookback period. Since the sale-leaseback model under ASC 840 did not apply to lessors, but the sale and
leaseback model in the new leases standard does, it is unclear whether the transition guidance in the new leases
standard for previous failed sale and leaseback transactions applies to lessor accounting. There are two potential
approaches to address this question:
1.
Lessors should reassess previous “failed” sale and leaseback transactions under ASC 840 that occurred prior to
the effective date to determine if they would have continued to fail under the new leases standard during the
lookback period. If such a transaction failed to qualify as a sale under the new leases guidance, the buyer-lessor
should account for the transaction as a financing, i.e., a loan to the seller-lessee.
2. Since the sale-leaseback guidance under ASC 840 was not applicable to lessors, a buyer-lessor should not
reassess a successful purchase with respect to a previous sale and leaseback transaction that did not qualify for
sale-leaseback accounting under ASC 840. Instead, for successful purchases, buyer-lessors should account for
the leaseback in accordance with the normal lessor transition guidance.
We understand it was not the Board’s intent that a buyer-lessor should reassess a successful purchase per the guidance
under the new standard. Hence, we believe option (2) is the appropriate approach.
Question 51: Must lessees apply sale and leaseback transition guidance under the new leases standard to failed sale and
leaseback transactions under ASC 840 that existed prior to the effective date of the new leases standard when such
failed sale and leaseback transactions resulted from failed build-to-suit transactions under ASC 840?
Discussion: Under ASC 840 and the new leases standard, a lessee that is deemed to be the owner of a construction
project due to a failed build-to-suit transaction must evaluate the transaction upon construction completion to
determine if it qualifies for sale-leaseback accounting.
The transition guidance in the new leases standard does not explicitly address the transition for a transaction that failed
the sale and leaseback guidance under ASC 840 once construction was completed (either prior to or during the lookback
period) because the transaction failed the build-to-suit guidance under ASC 840. We believe that in such instances,
since the reason for the failed sale-leaseback was due to a failed build-to-suit under ASC 840, the lessee should also be
eligible to apply the transition guidance applicable to the failed build-to-suit, i.e., the lessee would not have to apply the
sale and leaseback transition guidance for a failed sale and leaseback transaction. Instead, at the later of the beginning
of the lookback period and the date the lessee was determined to be the accounting owner under ASC 840, the lessee
would derecognize the assets and liabilities recorded and record any difference as an adjustment to equity. After such
date, the lessee would follow the lessee transition requirements for the lease.
Build-to-suit leases
Under ASC 840, lessees involved in the construction of a leased asset (“build-to-suit” arrangements), evaluated whether
or not they should be deemed the accounting owner of the asset during the construction period based on what was
largely an economic risk based model. If a lessee was deemed to be the owner of an asset under construction, the lessee
would apply the sale-leaseback guidance under ASC 840 once construction was complete. Under the new leases
guidance, a new build-to-suit model based on whether the lessee controls the asset is applicable to lessees and lessors. If
the lessee controls the asset during construction, similar to current GAAP, the lessee would capitalize the construction
costs as if it were the owner of the asset during the construction period and recognize a liability for any amounts funded
by the lessor. At construction completion, the lessee would apply the new sale and leaseback model to determine if the
arrangement qualifies for sale and leaseback accounting. However, unlike the current rules, the new build to suit and
sale-leaseback rules also will apply to lessors. So in circumstances when a lessee controls a construction project, a lessor
would recognize any payments as a loan to the lessee.
The transition guidance in the new leases standard provides the following guidance for lessees that were involved with
build-to-suit arrangements under ASC 840 that were entered into during the lookback period or existed as of the
beginning of the lookback period.

If a lessee recognized assets and liabilities because the lessee failed to meet the requirements under the build-
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to-suit guidance in ASC 840, such assets and liabilities should be derecognized at the later of the beginning of
the earliest comparative period presented and the date that the lessee is determined to be the accounting owner
of the asset being constructed under ASC 840, with any difference recorded as an adjustment to equity. The
lessee would then apply the lessee transition guidance for the lease.
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If the construction was complete prior to the beginning of the lookback period and the transaction qualified for
sale-leaseback accounting under ASC 840, the lessee should follow the lessee transition requirements for the
lease.
Question 52: Should lessees evaluate and account for build-to-suit transactions that existed during the lookback period
under the new build-to-suit guidance?
Discussion: The new leases standard does not specifically address how the new build-to-suit model should be applied to
build-to-suit transactions that exist during the lookback period. We believe the accounting will depend on the stage of
the project.
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If there are no assets and liabilities recognized by the lessee as a result of a construction project on the effective
date (i.e., the lessee was either not the owner during construction under ASC 840 or the transaction qualified as
a sale-leaseback), we believe the lessee should follow the normal lease transition requirements for the lease at
the effective date.
If construction is complete as of the effective date and assets and liabilities have been recognized by the lessee
as a result of the construction project as of the effective date, we believe the lessee should derecognize such
assets and liabilities pursuant to ASC 842-10-65-1(u)(1). Any difference should be recorded as an adjustment to
equity. The lessee would then follow the normal lease transition guidance.
If construction is still in progress as of the effective date, we believe the transaction should be reassessed under
the control-based build-to-suit model in the new leases standard. If the lessee is deemed to control the asset
under construction under the new leases standard, the lessee should recognize the asset under construction at
the later of the earliest period presented or the date control over the asset under construction was established. A
lessee that controls the asset being constructed would then also need to assess the transaction under the sale
and leaseback provisions of the new leases standard
What’s next
At its meeting on June 21, 2017, the FASB directed the staff to draft a proposed Accounting Standards Update on 16
technical corrections and improvements to the new leases standard with a comment period of 45 days.
For entities that have early adopted the new leases standard, the FASB decided that the proposed amendments would
be effective upon their issuance and would follow the transition guidance in the new leases standard. For entities that
have not adopted the new leases standard, the effective date and transition requirements for the proposed amendments
will be the same as the effective date and transition requirements in the new leases standard. As companies continue
their implementation efforts, we anticipate additional issues will be identified. We also expect many of these items to be
resolved through discussions among industry working groups, accounting firms, the FASB, and regulators. It is possible
that views on certain issues may change as a result of these ongoing discussions. As additional issues are raised and
consensus views are formed, we may provide updates.
The issues in this publication highlight the need for companies to start or accelerate their implementation efforts to
identify areas of concern. There are areas of interaction between the new leases guidance and other standards that may
have a significant impact on lessees and lessors. Companies will need time to design and implement processes, controls,
and systems to capture the necessary data to implement the standard for transition and subsequent periods. In
addition, to the extent the new standard will have a significant impact on companies’ financial statements, companies
should begin now to consider how to communicate the potential impact to their stakeholders.
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PwC has developed the following publications and resources related to the leases standard, covering topics relevant to a
broad range of constituents.
– PwC Guide: Leases
– In brief US2016-05, Lease accounting: The long-awaited FASB standard has arrived
– In the loop - Are leases embedded in your contracts?
– In the loop - Lessor accounting: how the new lease and revenue standards interact
– In depth US2016-02, The leasing standard – A comprehensive look at the new model and its impact
– Industry-specific supplements available (more to come):
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o
o
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o
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o
o
o
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Automotive
Telecommunications
Energy
Entertainment and media
Higher education
Insurance
Pharmaceuticals and life sciences
Retail and consumer
Technology
Transportation and logistics
Click on the titles above to obtain a copy of each publication. PwC clients who have questions about any of these
publications should contact their engagement partner. Prospective clients and friends should contact the managing
partner of the nearest PwC office, which can be found at www.pwc.com.
To have a deeper discussion, contact:
John Bishop
Partner
john.bishop@pwc.com
Shannon Detling
Director
shannon.b.detling@pwc.com
Ashima Jain
Managing Director
ashima.jain@pwc.com
Brian Wiegmann
Director
brian.c.wiegmann@pwc.com
Suzanne Stephani
Director
suzanne.stephani@pwc.com
Brandon Campbell Jr.
Director
brandon.a.campbell.jr@pwc.com
Follow @CFOdirect on Twitter.
© 2017 PricewaterhouseCoopers LLP, a Delaware limited liability partnership. All rights reserved. PwC refers to the United States member firm, and may sometimes refer to the PwC network. Each
member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for
consultation with professional advisors.