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www.pwc.com Leases 2016 This publication has been prepared for general informational purposes, and does not constitute professional advice on facts and circumstances specific to any person or entity. You should not act upon the information contained in this publication without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication. The information contained in this publication was not intended or written to be used, and cannot be used, for purposes of avoiding penalties or sanctions imposed by any government or other regulatory body. PricewaterhouseCoopers LLP, its members, employees, and agents shall not be responsible for any loss sustained by any person or entity that relies on the information contained in this publication. The content of this publication is based on information available as of March 31, 2016. Accordingly, certain aspects of this publication may be superseded as new guidance or interpretations emerge. Financial statement preparers and other users of this publication are therefore cautioned to stay abreast of and carefully evaluate subsequent authoritative and interpretative guidance. Portions of various FASB documents included in this work are copyrighted by the Financial Accounting Foundation, 401 Merritt 7, Norwalk, CT 06856, and are reproduced with permission. PwC guide library Other titles in the PwC accounting and financial reporting guide series: Bankruptcies and liquidations (2014) Business combinations and noncontrolling interests, global edition (2014), second edition Consolidation and equity method of accounting (2015) Derivative instruments and hedging activities (2013), second edition Fair value measurements, global edition (2015) Financial statement presentation (2014), second edition Financing transactions: debt, equity and the instruments in between (2014), second edition Foreign currency (2014) IFRS and US GAAP: similarities and differences (2015) Income taxes (2013), second edition Revenue from contracts with customers, global edition (2014) Stock-based compensation (2013), second edition Transfers and servicing of financial assets (2013) Utilities and power companies (2013) Variable interest entities (2013), second edition PwC i Acknowledgments The Leases guide represents the efforts and ideas of many individuals within PwC. The following PwC people contributed to the contents or served as technical reviewers of this publication: Takashi Anraku John Bishop Roberta Chmielnik Justin Frenzel Ashima Jain Marc Jerusalem Nora Joyce Ralph Martino Chuck Melko Lauren Murphy Brian Ness Jeff Normant Jonathan Rhine Chad Soares Bill Staffieri Suzanne Stephani Valerie Wieman ii PwC Preface PwC is pleased to offer the first edition of our Leases guide. In February 2016, the FASB issued its standard on leases, ASC 842, which will replace today's leases guidance in 2019. The chapters in this guide discuss both lessee and lessor accounting by topic. For example, LG 3 discusses lease classification for both lessees and lessors. The first four chapters provide an introduction and guidance on determining whether an arrangement is (or contains) a lease and how to classify and account for lease and nonlease components. This guide also discusses the modification, remeasurement, and termination of a lease, sale and leaseback transactions, leveraged lease transactions, as well as other topics. Finally, this guide contains chapters on the presentation and disclosure requirements, as well as the effective date and transition. Locating guidance on particular topics Guidance on particular topics can be located as follows: Table of contentsThe table of contents provides a detailed listing of the various sections in each chapter. The titles of each section are intentionally descriptive to enable users to easily find a particular topic. Table of questionsThe table of questions includes a listing of questions and PwC responses in numerical order, by chapter. Table of examplesThe table of examples includes a listing of examples in numerical order, by chapter. The guide also includes a detailed index of key topics. References to US GAAP Definitions, full paragraphs, and excerpts from the Financial Accounting Standards Board's Accounting Standards Codification are clearly designated, either within quotes in the regular text or enclosed within a shaded box. In some instances, guidance was cited with minor editorial modification to flow in the context of the PwC Guide. The remaining text is PwC's original content. References to other chapters and sections in this guide Where relevant, the discussion includes general and specific references to other chapters of the guide that provide additional information. References to another chapter or particular section within a chapter are indicated by the abbreviation \"LG\" followed by the specific section number (e.g., LG 2.3.2 refers to section 2.3.2 in chapter 2 of this guide). PwC iii Preface References to other PwC guidance This guide focuses on the accounting and financial reporting considerations for leases. It supplements information provided by the authoritative accounting literature and other PwC guidance. This guide provides general and specific references to chapters in other PwC guides to assist users in finding other relevant information. References to other guides are indicated by the applicable guide abbreviation followed by the specific section number. The other PwC guides referred to in this guide, including their abbreviations are: Business combinations and noncontrolling interests (BCG) Derivative instruments and hedging activities (DH) Fair value measurements (FV) Financial statement presentation (FSP) Financing transactions: debt, equity and the instruments in between (FG) Income taxes (TX) Stock-based compensation (SC) Transfers and servicing of financial assets (TS) Variable interest entities (VE) All references to the guides are to the latest editions noted in the PwC guide library. In addition, PwC's Accounting and reporting manual (the ARM) provides information about various accounting matters in US GAAP. Copies of the other PwC guides may be obtained through CFOdirect, PwC's comprehensive online resource for financial executives (www.cfodirect.com), a subscription to Inform, PwC's online accounting and financial reporting reference tool (www.pwcinform.com), or by contacting a PwC representative. Guidance date As the environment continues to change, so will the content in this guide. This guide considers existing guidance as of March 31, 2016. Future editions will be released to keep pace with significant developments. Certain events, such as the issuance of a new pronouncement by the FASB, a consensus (and ensuing endorsement by the FASB) of the Emerging Issues Task Force, or new SEC rules or guidance, may necessitate an update or supplement to the guide. Updates or supplements that may be in the form of other PwC communications can be found on CFOdirect (www.cfodirect.com) or Inform (www.pwcinform.com). iv PwC Preface Other information The appendices to this guide include guidance on professional literature, a listing of technical references and abbreviations, and definitions of key terms. ***** This guide has been prepared to support you in applying the leases accounting guidance. It should be used in combination with a thorough analysis of the relevant facts and circumstances, review of the authoritative accounting literature, and appropriate professional and technical advice. We hope you find the information and insights in this guide useful. We will continue to share with you additional perspectives and interpretations as they develop. Paul Kepple US Chief Accountant 2016 PwC v Table of contents Chapter 1: Introduction 1.1 Background ........................................................................ 1-2 1.2 High-level overview ............................................................ 1-4 1.2.1 Denition and scope ........................................................... 1-5 1.2.2 Lessee classication ........................................................... 1-6 1.2.3 Lessor classication ........................................................... 1-6 1.3 Comparison of ASC 842 and ASC 840 ................................. 1-6 1.4 Disclosures......................................................................... 1-11 1.5 Transition and effective date .............................................. 1-11 1.6 Implementation guidance .................................................. 1-12 Chapter 2: Scope 2.1 Chapter overview ............................................................... 2-2 2.2 Exceptions to applying lease accounting ............................. 2-2 2.2.1 Short-term lease exception for lessees ............................... 2-3 2.3 Denition of a lease ............................................................ 2-3 2.3.1 Use of an identied asset .................................................... 2-5 2.3.1.1 Explicitly identied asset...................................................................... 2-5 2.3.1.2 Implicitly identied asset ..................................................................... 2-5 2.3.1.3 Physically distinct ................................................................................. 2-6 2.3.1.4 Substantive substitution rights ............................................................ 2-7 2.3.2 Right to control the use of an identied asset over the period of use ...................................................................... 2-11 2.3.2.1 The right to obtain substantially all of the economic benets ............. 2-12 2.3.2.2 Right to direct the use of the identied asset ....................................... 2-14 2.3.2.3 Examples - the right to control the use of an identied asset ............ 2-18 2.4 Separating lease and nonlease components ....................... 2-21 2.4.1 Identifying lease and nonlease components ....................... 2-22 2.4.2 Lessor allocation of consideration to lease and nonlease components ......................................................... 2-23 Lessee allocation of consideration to lease and nonlease components ......................................................... 2-24 2.4.3.1 Practical expedient for lessees .............................................................. 2-25 2.4.4 Allocation of variable consideration ................................... 2-25 2.4.4.1 Allocating variable consideration for lessors ....................................... 2-25 2.4.3 vi PwC Table of contents 2.4.4.2 Allocating variable consideration for lessees ....................................... 2-33 2.5 Components within a lease ................................................. 2-34 2.5.1 Portfolio exception ............................................................. 2-36 2.5.2 Reallocation of consideration ............................................. 2-36 2.6 Reassessment of whether a contract contains a lease ......... 2-37 Chapter 3: Lease classication 3.1 Chapter overview ............................................................... 3-2 3.2 Overview of lease classication .......................................... 3-2 3.2.1 Lease commencement ........................................................ 3-5 3.2.2 Lease components .............................................................. 3-6 3.3 Lease classication criteria ................................................ 3-6 3.3.1 Transfer of ownership ........................................................ 3-9 3.3.2 Option to purchase the underlying asset is reasonably certain of exercise .............................................................. 3-10 3.3.2.1 Purchase option prices ......................................................................... 3-10 3.3.3 Lease term is for the major part of the remaining economic life of the asset.................................................... 3-10 3.3.3.1 Determining the term of the lease ........................................................ 3-11 3.3.3.2 Determining the estimated economic life ............................................ 3-13 3.3.3.3 Determining the estimated economic life of a lease component with multiple underlying assets ........................................................... 3-15 Present value of the lease payments amounts to substantially all of the fair value of the underlying asset .... 3-15 3.3.4.1 Fixed lease payments ............................................................................ 3-17 3.3.4.2 Lease incentives .................................................................................... 3-18 3.3.4.3 Variable lease payments ....................................................................... 3-19 3.3.4.4 Residual value guarantees .................................................................... 3-24 3.3.4.5 Fair value of the underlying asset ........................................................ 3-26 3.3.4.6 Discount rate......................................................................................... 3-28 3.3.4.7 Collectibility (lessors) ........................................................................... 3-29 3.3.5 Underlying asset is of a specialized nature ......................... 3-31 3.4 Application of the \"reasonably certain\" threshold .............. 3-31 3.5 Lessee classication examples............................................ 3-32 3.5.1 Finance leases .................................................................... 3-33 3.5.2 Operating lease .................................................................. 3-37 3.6 Lessor classication examples............................................ 3-44 3.6.1 Sales-type lease .................................................................. 3-44 3.3.4 PwC vii Table of contents 3.6.2 Operating lease .................................................................. 3-49 Chapter 4: Accounting for leases 4.1 4-2 4.2 Initial recognition and measurement - lessee .................... 4-2 4.2.1 Measuring the lease liability ............................................... 4-2 4.2.2 Measuring the right-of-use asset ........................................ 4-3 4.2.2.1 Payments made at or before the commencement date, less lease incentives received................................................................................ 4-3 4.2.2.2 Initial direct costs ................................................................................. 4-3 4.2.2.3 Examples - measuring the right-of-use asset ...................................... 4-4 4.3 Initial recognition and measurement - lessor .................... 4-15 4.3.1 Sales-type lease .................................................................. 4-15 4.3.1.1 Selling prot / selling loss .................................................................... 4-16 4.3.1.2 Initial direct costs ................................................................................. 4-17 4.3.1.3 When collectibility is not probable at the commencement date for a sales-type lease ............................................................................. 4-17 4.3.1.4 Examples - lessor accounting for sales-type leases............................. 4-19 4.3.2 Direct nancing lease ......................................................... 4-24 4.3.2.1 Initial measurement of net investment in the lease ............................ 4-24 4.3.3 Operating lease .................................................................. 4-25 4.3.3.1 When collectibility is not probable at the commencement date for an operating lease ........................................................................... 4-25 4.3.3.2 Examples - lessor accounting for operating leases ............................. 4-26 4.4 Subsequent recognition and measurement - lessee ........... 4-27 4.4.1 Finance leases .................................................................... 4-28 4.4.1.1 Finance lease with a purchase option .................................................. 4-29 4.4.2 Operating leases ................................................................. 4-31 4.5 Subsequent recognition and measurement - lessor ........... 4-33 4.5.1 Lessor sales-type leases and direct nancing lease ............. 4-34 4.5.2 Lessor operating leases ...................................................... 4-35 4.6 Impairment - lessee ........................................................... 4-37 4.6.1 Finance leases .................................................................... 4-37 4.6.2 Operating lease .................................................................. 4-37 4.7 Impairment - lessor ........................................................... 4-38 4.7.1 Sales-type and direct nancing leases ................................ 4-38 4.7.2 viii Chapter overview ............................................................... Operating leases ................................................................. 4-38 PwC Table of contents Chapter 5: Modication, remeasurement, and termination of a lease 5.1 Chapter overview ............................................................... 5-2 5.2 Accounting for a lease modication - lessee ...................... 5-2 5.2.1 Lessee accounting for a lease modication ......................... 5-3 5.2.1.1 Separate new lease ................................................................................ 5-3 5.2.1.2 Modied lease ....................................................................................... 5-5 5.3 Accounting for lease remeasurement - lessee .................... 5-5 5.3.1 Lease remeasurement for a change in lease payments or the probability of exercising an option ........................... 5-7 5.3.2 Remeasurement of lease liability........................................ 5-9 5.3.3 Right-of-use asset adjustment ............................................ 5-10 5.3.4 Lease expense subsequent to remeasurement .................... 5-10 5.3.4.1 Finance lease upon remeasurement..................................................... 5-10 5.3.4.2 Operating lease upon remeasurement ................................................. 5-10 5.3.5 Illustrative examples of lease remeasurement ................... 5-11 5.4 Lessee reassessment of short-term lease exception ............ 5-24 5.5 Accounting for a lease termination - lessee........................ 5-25 5.5.1 Accounting for a partial lease termination ......................... 5-25 5.5.2 Purchase of a leased asset during the lease term ................ 5-26 5.6 Accounting for a lease modication - lessor ...................... 5-26 5.6.1 Separate new lease ............................................................. 5-27 5.6.2 Modied lease .................................................................... 5-27 5.6.2.1 Direct nancing lease prior to the modication .................................. 5-27 5.6.2.2 Operating lease prior to the modication ............................................ 5-34 5.6.2.3 Sales-type lease prior to the modication ............................................ 5-39 5.7 Accounting for a lease termination - lessor ....................... 5-40 Chapter 6: Sale and leaseback transactions 6.1 Chapter overview ............................................................... 6-2 6.2 Sale and leaseback transactions ......................................... 6-2 6.2.1 Sale and leaseback-sublease transactions........................... 6-3 6.3 Determining whether a sale has occurred .......................... 6-3 6.3.1 Existence of a contract ....................................................... 6-3 6.3.2 Indicators that control of an asset has been obtained ......... 6-4 6.3.2.1 Seller-lessee has a present right to payment (or buyer-lessor has a present obligation to make payment) ......................................... 6-5 Buyer-lessor has legal title.................................................................... 6-5 6.3.2.2 PwC ix Table of contents 6.3.2.3 Buyer-lessor has physical possession ................................................... 6-5 6.3.2.4 Buyer-lessor has the signicant risks and rewards of ownership ....... 6-5 6.3.2.5 Buyer-lessor has accepted the asset ..................................................... 6-6 6.3.2.6 Impact of a prospective lessee obtaining control of an underlying asset prior to lease commencement ..................................................... 6-6 6.3.3 Lessee involvement in construction of leased asset ............ 6-7 6.3.3.1 Construction costs incurred by a lessee ............................................... 6-11 6.3.4 Impact of lease classication on qualication as a sale ....... 6-11 6.3.5 Repurchase rights and obligations in a sale and leaseback transaction ......................................................... 6-12 Seller-lessee has a repurchase option or the transaction is subject to a forward ........................................................................................... 6-12 6.3.5.2 Buyer-lessor has a put option ............................................................... 6-13 6.4 When the transaction qualies as a sale ............................. 6-14 6.4.1 Accounting by the seller-lessee ........................................... 6-15 6.4.2 Accounting by the buyer-lessor .......................................... 6-16 6.4.3 Costs in a sale and leaseback transaction ........................... 6-16 6.4.4 Accounting for sale and leaseback transactions entered into at off-market terms ..................................................... 6-17 6.4.4.1 Seller-lessee accounting for a transaction with off-market terms ....... 6-18 6.4.4.2 Buyer-lessor accounting for a transaction with off-market terms ...... 6-21 6.5 Transaction is not accounted for as a sale (failed sale and leaseback).................................................................... 6-22 Accounting for a failed sale and leaseback by a seller-lessee........................................................................ 6-23 6.5.1.1 Allocation of the leaseback payments by a seller-lessee ...................... 6-23 6.5.1.2 Accounting by a seller-lessee when the buyer-lessor obtains control of the asset after lease commencement ................................... 6-24 Accounting by the seller-lessee when the leaseback is for a portion of the asset ............................................................................... 6-29 Accounting for a failed sale and leaseback by a buyer-lessor ....................................................................... 6-31 Accounting by the buyer-lessor when it obtains control of the asset ................................................................................................ 6-31 6.3.5.1 6.5.1 6.5.1.3 6.5.2 6.5.2.1 Chapter 7: Leveraged leases 7.1 7-2 7.2 Denition and characteristics of a leveraged lease ............. 7-2 7.2.1 Classication criteria for leveraged leases.......................... 7-2 7.2.2 x Chapter overview ............................................................... Economic rationale for leveraged leases............................. 7-3 PwC Table of contents 7.2.3 Financial statement presentation of leveraged leases and income recognition ...................................................... 7-3 7.3 Changes to a leveraged lease arrangement ......................... 7-4 7.3.1 Changes to the fundamental characteristics of a leveraged lease ................................................................... 7-4 7.3.1.1 Requirement for a long-term creditor.................................................. 7-5 7.3.1.2 Requirement for substantial leverage .................................................. 7-5 7.3.1.3 Requirement for nonrecourse debt ...................................................... 7-5 7.3.2 Modications to a leveraged lease ...................................... 7-6 7.3.2.1 Replacing the lessee .............................................................................. 7-6 7.3.2.2 Discontinuing the use of leveraged lease accounting .......................... 7-6 7.3.3 Changes in the underlying assumptions ............................. 7-7 7.4 Leveraged leases acquired in a business combination ........ 7-8 Chapter 8: Other topics 8.1 Chapter overview ............................................................... 8-2 8.2 Subleases ........................................................................... 8-2 8.2.1 Accounting by the intermediate lessor ............................... 8-3 8.2.1.1 Accounting for the arrangement when the intermediate lessor is not relieved of its primary obligation under the head lease............. 8-3 Intermediate lessor is relieved of its primary obligation under the head lease........................................................................................ 8-5 8.2.2 Accounting by the head lessor ............................................ 8-5 8.3 Sale of leased assets ........................................................... 8-6 8.4 Sale of lease receivables and residual assets ....................... 8-6 8.4.1 Accounting for the sale of a lease receivable ....................... 8-6 8.4.2 Accounting for the sale of an unguaranteed residual asset in a direct nancing or a sales-type lease ................... 8-7 Accounting for the purchase of an interest in the residual value of a leased asset ........................................... 8-7 8.4.3.1 Purchase of an unguaranteed residual asset ........................................ 8-7 8.4.3.2 Purchase of guaranteed residual asset ................................................. 8-8 8.5 Sales of equipment with guaranteed minimum resale amount ............................................................................... 8-8 Sales of equipment with guaranteed minimum resale amount accounted for as an operating lease ....................... 8-9 Evaluating a guaranteed minimum resale agreement to determine whether it contains an embedded derivative ..... 8-10 8.6 Business combinations ....................................................... 8-10 8.6.1 Acquiree in a business combination is a lessee ................... 8-11 8.2.1.2 8.4.3 8.5.1 8.5.2 PwC xi Table of contents 8.6.2 Acquiree in a business combination is a lessor ................... 8-11 Chapter 9: Presentation and disclosure 9.1 Chapter overview ............................................................... 9-2 9.2 Lessees ............................................................................... 9-2 9.2.1 Balance sheet presentation ................................................ 9-2 9.2.1.1 Right-of-use asset ................................................................................. 9-2 9.2.1.2 Lease liability ........................................................................................ 9-3 9.2.2 Statement of comprehensive income .................................. 9-3 9.2.2.1 Finance lease ......................................................................................... 9-3 9.2.2.2 Operating lease ..................................................................................... 9-3 9.2.3 Statement of cash ows ...................................................... 9-4 9.2.3.1 Finance lease ......................................................................................... 9-4 9.2.3.2 Operating lease ..................................................................................... 9-4 9.2.4 Qualitative disclosure ......................................................... 9-4 9.2.5 Quantitative disclosure ...................................................... 9-5 9.3 Lessors ............................................................................... 9-7 9.3.1 Balance sheet presentation ................................................ 9-7 9.3.1.1 Sales-type and direct nancing leases .................................................. 9-7 9.3.1.2 Operating lease ..................................................................................... 9-7 9.3.2 Statement of comprehensive income .................................. 9-7 9.3.2.1 Sales-type and direct nancing leases .................................................. 9-8 9.3.2.2 Operating lease ..................................................................................... 9-8 9.3.2.3 Subleases ............................................................................................... 9-8 9.3.3 Statement of cash ows ...................................................... 9-8 9.3.4 Disclosure .......................................................................... 9-8 9.3.4.1 Sales-type and direct nancing leases .................................................. 9-9 9.3.4.2 Operating leases.................................................................................... 9-10 9.4 Sale and leaseback transactions ......................................... 9-11 9.5 Leveraged leases ................................................................ 9-11 9.6 Related party leases............................................................ 9-11 9.7 Transition disclosures ........................................................ 9-11 Chapter 10: Effective date and transition 10.1 10-2 10.2 Effective date ...................................................................... 10-2 10.3 xii Chapter overview ............................................................... Transition .......................................................................... 10-3 PwC Table of contents 10.3.1 Lessee transition ................................................................ 10-3 10.3.1.1 Operating leases.................................................................................... 10-3 10.3.1.2 Capital leases ........................................................................................ 10-4 10.3.1.3 Build-to-suit leases ............................................................................... 10-5 10.3.2 Lessor transition ................................................................ 10-5 10.3.2.1 Operating leases.................................................................................... 10-5 10.3.2.2 Finance leases ....................................................................................... 10-6 10.3.2.3 Leveraged leases ................................................................................... 10-6 10.3.3 Practical expedients ........................................................... 10-6 10.3.4 Sale and leaseback.............................................................. 10-7 10.3.5 Amounts previously recognized in business combinations ..................................................................... 10-8 Appendices Appendix A A-1 Appendix B Technical references and abbreviations .................... B-1 Appendix C PwC Professional literature............................................... Key terms .................................................................. C-1 xiii Table of questions Chapter 2: Scope Question 2-1: Question 2-2: Is a substitution right that requires customer approval considered substantive?........................................................ 2-7 If a solar facility sells its energy production and RECs to separate parties, which party has the right to obtain substantially all of the economic benets of the solar facility? ............................................................... 2-13 Chapter 3: Lease classication Question 3-1: Question 3-2: Question 3-3: Question 3-4: How should leases between related parties be classied? .............................................................................. 3-5 If a lessee classies a lease as a nance lease, must the lessor do so as well? .............................................................. 3-9 Can the classication criteria be applied to a group of leased assets (i.e., a portfolio approach)?............................. 3-9 Do the lease classication criteria in ASC 842-10-25-2 and 25-3 apply to leases of land? .......................................... 3-9 Question 3-5: Question 3-6: Is a lease with a scal funding clause (a clause included in some leases with federal, state, and local government that gives the lessee the right to cancel if funds are not appropriated in future years) considered noncancelable? ...................................................................... 3-12 Question 3-7: Are the costs associated with removing leasehold improvements installed by the lessee (i.e., a lessee's obligation to return an underlying asset to its original condition) considered lease payments? ............................... 3-16 Question 3-8: Are the costs a lessee incurs to dismantle and remove an underlying asset at the end of the lease term considered lease payments? .................................................................... 3-17 Question 3-9: xiv How should a lessee consider its past practices in assessing whether it is reasonably certain to exercise an option to renew a lease or to purchase an underlying asset? ..................................................................................... 3-12 Should a lessee consider a residual value guarantee in the lease classication determination differently than how it considers the guarantee when measuring its lease liability? ........................................................................ 3-24 PwC Table of questions Chapter 5: Modication and remeasurement of a lease Question 5-1: Question 5-2: Lessee Corp enters into a ve-year lease with payments that increase based on increases in the Consumer Price Index (CPI), but cannot decrease. As CPI increases, should lease payments be adjusted to include the impact of the increase to date? ............................................. 5-7 Lessee Corp enters into a ve-year lease with payments that increase based on increases to the CPI, capped at a cumulative increase of 7%. When CPI reaches the cap, should lease payments be adjusted to include the 7% increase? .......................................................................... 5-8 Chapter 9: Presentation and disclosure Question 9-1: PwC When a lessee discloses information about leases that have not yet commenced, but that create signicant rights and obligations for the lessee based on the guidance in ASC 842-20-50-3(b) should it also consider the guidance in ASC 450, Contingencies? ............................ 9-5 xv Table of examples Chapter 2: Scope Example 2-1: Bank data center contract ..................................................... 2-6 Example 2-2: Automobile hood ornament contract ................................... 2-6 Example 2-3: Supplier with substantive substitution rights ...................... 2-9 Example 2-4: Supplier without substantive substitution rights ................. 2-10 Example 2-5: Supplier with substantive substitution rights ...................... 2-10 Example 2-6: Contract to manufacture parts on a customer's property .... 2-18 Example 2-7: Contract to purchase electricity on an on-demand basis ..... 2-19 Example 2-8: Contract to purchase electricity on a full-time basis............ 2-20 Example 2-9: Contract for use of an airplane over a three-year period ..... 2-20 Example 2-10: Contract for use of a grain storage facility ........................... 2-21 Example 2-11: Allocating variable consideration - contract for sale of medical equipment and disposables (sales-type lease) ....... 2-27 Example 2-12: Allocating variable consideration - contract for sale of medical equipment and disposables (sales-type lease) ....... 2-29 Example 2-13: Allocating variable consideration - contract for sale of medical equipment and disposables (sales-type lease) ....... 2-31 Example 2-14: Lease of a fully furnished ofce building.............................. 2-35 Chapter 3: Lease classication Example 3-1: Example 3-2: Lease term - ground lease with a renewal option ............... 3-13 Example 3-3: Estimated economic life - economic life of a new asset (manufacturing equipment) ................................................. 3-14 Example 3-4: Estimated economic life - economic life of a used asset (real estate) ........................................................................... 3-15 Example 3-5: Lease payments - determining the xed payments............. 3-17 Example 3-6: Lease payments - variable lease payments tied to an index ................................................................................. 3-20 Example 3-7: Lease payments - variable lease payments.......................... 3-21 Example 3-8: Lease payments - payments tied to use of medical device consumables .............................................................. 3-22 Example 3-9: Lease payments - payments tied to sales ............................ 3-23 Example 3-10: Lease payments - in substance xed lease payments ......... 3-23 Example 3-11: xvi Lease term - ground lease with a renewal option ............... 3-13 Discount rate - portfolio discount rate ................................ 3-29 PwC Table of examples Example 3-12: Lease classication - non-specialized digital imaging equipment lease (lessee) ....................................................... 3-33 Example 3-13: Lease classication - real estate lease with a purchase option (lessee) ....................................................................... 3-34 Example 3-14: Lease classication - automobile lease (lessee) .................. 3-37 Example 3-15: Lease classication - copier with lease and nonlease components (lessee) ............................................................. 3-39 Example 3-16: Lease classication - lease payments tied to an index (lessee)......................................................................... 3-42 Example 3-17: Lease classication - non-specialized digital imaging equipment lease (lessor) ....................................................... 3-44 Example 3-18: Lease classication - real estate lease with a purchase option (lessor) ....................................................................... 3-46 Example 3-19: Lease classication - automobile lease (lessor)................... 3-49 Chapter 4: Accounting for leases Example 4-1: Measuring the right-of-use asset .......................................... 4-4 Example 4-2: Finance lease initial recognition - non-specialized digital imaging equipment lease (lessee) ............................. 4-6 Finance lease recognition - real estate lease with a purchase option (lessee) ....................................................... 4-7 Example 4-3: Example 4-4: Example 4-5: Lessee operating lease recognition - copier with lease and nonlease components .................................................... 4-12 Example 4-6: Lessee operating lease recognition - lease payments tied to an index...................................................................... 4-13 Example 4-7: Sales-type lease recognition - non-specialized digital imaging equipment lease (lessor) ......................................... 4-19 Example 4-8: Sales-type lease recognition - real estate with a purchase option (lessor) ....................................................... 4-21 Example 4-9: Lessor operating lease recognition - automobile lease ....... 4-26 Example 4-10: Finance lease subsequent measurement and recognition - non-specialized digital imaging equipment lease (lessee) ....................................................... 4-28 Example 4-11: Finance lease subsequent measurement and recognition - real estate lease with a purchase option (lessee) .................................................................................. 4-30 Example 4-12: Lessee operating lease subsequent measurement and recognition - automobile lease ............................................ 4-32 Example 4-13: PwC Lessee operating lease recognition - automobile lease ....... 4-10 Sales-type lease subsequent measurement and recognition - non-specialized digital imaging equipment lease (lessor) ....................................................... 4-34 xvii Table of examples Example 4-14: Lessor operating lease subsequent measurement and recognition - automobile lease ............................................ 4-36 Chapter 5: Modication and remeasurement of a lease Example 5-1: Modication that is a separate new lease ............................. 5-4 Example 5-2: Remeasurement of an operating lease with variable lease payments ...................................................................... 5-11 Example 5-3: Remeasurement of nance lease for a change in expected purchase option exercise ....................................... 5-13 Example 5-4: Remeasurement of a nance lease for a change in the probability of payment for a residual value guarantee ........ 5-16 Example 5-5: Accounting for a modied operating lease that extends the lease term classied as an operating lease ..................... 5-19 Example 5-6: Accounting for a modied operating lease with a decrease in lease term ........................................................... 5-21 Example 5-7: Accounting for a change in consideration in an operating lease ...................................................................... 5-23 Example 5-8: Modication of a direct nancing lease that does not impact classication.............................................................. 5-28 Example 5-9: Modication of a direct nancing lease that changes lease classication to a sales-type lease................................ 5-30 Example 5-10: Modication of a direct nancing lease that changes lease classication to an operating lease .............................. 5-32 Example 5-11: Modication of an operating lease that does not impact lease classication ................................................................. 5-35 Example 5-12: Modication of an operating lease that changes lease classication to a sales-type lease......................................... 5-37 Chapter 6: Sale and leaseback transactions Example 6-1: Example 6-2: Example 6-3: Sale and leaseback transaction - lessee obtains control prior to lease commencement .............................................. 6-6 Sale and leaseback transaction - lessee obtains title, but not control prior to lease commencement ..................... 6-7 Sale and leaseback transactions - lessee obtains control of construction in progress ................................................... 6-9 Example 6-4: Example 6-5: Sale and leaseback transactions - construction costs incurred by a lessee that does not obtain control of construction in process (real estate) .................................... 6-11 Example 6-6: xviii Sale and leaseback transactions - lessee does not obtain control of construction in process (real estate) .................... 6-10 Sale and leaseback transactions - gain on sale .................... 6-15 PwC Table of examples Example 6-7: Example 6-8: Sale and leaseback transaction - seller-lessee sells underlying asset for less than fair value ............................... 6-19 Example 6-9: Sale and leaseback transaction - seller-lessee sells underlying asset for a price that is greater than fair value................................................................................ 6-20 Example 6-10: Sale and leaseback transaction - buyer-lessor buys an underlying asset for an amount greater than fair value ....... 6-22 Example 6-11: Failed sale and leaseback - buyer-lessor does not obtain control of the underlying asset prior to the end of the leaseback term ...................................................................... 6-25 Example 6-12: Failed sale and leaseback - buyer-lessor does not obtain control of the underlying asset prior to the end of the leaseback term ...................................................................... 6-26 Example 6-13: Failed sale and leaseback - buyer-lessor does not obtain control of the underlying asset prior to the end of the leaseback term ...................................................................... 6-27 Example 6-14: Failed sale and leaseback - seller-lessee sells asset and buyer-lessor obtains control of the underlying asset prior to the end of the leaseback term .................................. 6-28 Example 6-15: Seller-lessee sells an asset and leases back a portion of the asset................................................................................. 6-29 Example 6-16: Failed sale and leaseback - buyer-lessor obtains control of the underlying asset at the end of the leaseback term ..... 6-31 Example 6-17: PwC Sale and leaseback transactions - loss on sale..................... 6-16 Buyer-lessor obtains control of the underlying asset prior to the end of the leaseback term .................................. 6-32 xix Chapter 1: Introduction PwC 1 Introduction 1.1 Background For many reporting entities, leasing is an important way to obtain access to property. It allows lessees to finance the use of necessary assets, often simplifies the disposal of used property, and reduces a lessee's exposure to the risks inherent in asset ownership. Leasing guidance (before the issuance of ASU 2016-02) required lessees to classify leases as either capital or operating leases. Lessees recognized assets and obligations related to capital leases; expenses associated with capital leases were recognized by amortizing the leased asset and recognizing interest expense on the lease obligation. Many lease arrangements were classified as operating leases, under which lessees would not recognize lease assets or liabilities on their balance sheet, but rather would recognize lease payments as expense on a straight line basis over the lease term. The leasing guidance was often criticized for not providing users the information necessary to understand a reporting entity's leasing activities, primarily because it did not provide users with a comprehensive understanding of the costs of property essential to a reporting entity's operations and how those costs were funded. Users frequently analyzed information from a reporting entity's lease-related disclosures to compare that reporting entity's performance with other companies. The user community and regulators frequently called for changes to the accounting requirements that would require lessees to recognize assets and liabilities associated with leases. In 2008, the FASB and IASB (collectively, the \"boards\") initiated a joint project to develop a new standard to account for leases. Although many of the perceived problems with the previous leasing guidance related to a lessee's accounting for operating leases, the boards thought it beneficial to reflect on lease accounting holistically, and to consider lessor accounting while concurrently developing a proposal on revenue recognition (ASC 606, Revenue from Contracts with Customers, which was issued in May 2014). The FASB issued ASU 2016-02 (the \"leasing standard\" or \"ASC 842\") in February 2016. Although the project began as a joint project, the boards diverged in some key areas. Most significantly, the boards did not agree on whether all leases should be accounted for using the same model. After significant deliberation, the IASB decided that lessees should apply a single model to all leases, which is reflected in IFRS 16, Leases, released in January 2016. The FASB decided that lessees should apply a dual model. Under the FASB model, lessees will classify a lease as either a finance lease or an operating lease, while a lessor will classify a lease as either a sales-type, direct financing, or operating lease. Under the FASB model, a lessee should classify a lease based on whether the arrangement is effectively a purchase of the underlying asset. Leases that transfer control of the underlying asset to a lessee are classified as finance leases (and as a sales-type lease for the lessor); lessees will classify all other leases as operating leases. In an operating lease, a lessee obtains control of only the use the underlying asset, but not the underlying asset itself. 1-2 PwC Introduction A lease may meet the lessee finance lease criteria even when control of the underlying asset is not transferred to the lessee (e.g., when the lessor obtains a residual value guarantee from a party other than the lessee). Such leases should be classified as a direct finance lease by the lessor and as an operating lease by the lessee. See LG 3 for information on the dual model adopted by the FASB. The dual model does not affect a lessee's initial recognition of assets and liabilities on its balance sheet, but differentiates how a lessee should recognize lease expense in the income statement. The accounting for lessors is largely unchanged under the FASB and IASB models. The following table includes a description of some of the most significant differences between the guidance in ASC 842 and IFRS 16. Figure 1-1 Summary of key differences between ASC 842 and IFRS 16 Topic Difference Lessee accounting ASC 842 requires a lessee to classify a lease as either a finance or operating lease. Interest and amortization expense are recognized for finance leases while only a single lease expense is recognized for operating leases, typically on a straight-line basis. Under IFRS 16, lessees will account for all leases in a manner similar to finance leases. Lessor accounting Under ASC 842, a sale and profit are recognized upon the commencement of a lease only when the arrangement transfers control of the underlying asset to the lessee. Under IFRS 16, selling profit is recognized on direct financing leases when performance obligations in IFRS 15, Revenue from Contracts with Customers, have been met. Statement of cash flows ASC 842 requires lessees to report the single expense associated with an operating lease as an operating activity. Under IFRS 16, lessees account for all leases similar to a financed purchase, with payments reported as a financing or operating activity in the statement of cash flows, in accordance with IAS 7, Statement of Cash Flows. PwC 1-3 Introduction Topic Difference Remeasurement of variable lease payments The initial measurement of lease-related assets and liabilities is similar under ASC 842 and IFRS 16; however, subsequent changes in lease payments that vary with a rate or index (e.g., rents that increase for changes in an inflation index) are accounted for differently. Under ASC 842, such changes are recognized when incurred, unless the lessee is otherwise required to remeasure the lease liability (e.g., as a result of reassessing the lease term). Under IFRS 16, lease assets and liabilities are remeasured whenever the cash flow changes. Sale and leaseback accounting Under ASC 842, a seller-lessee would recognize the full gain from a sale and leaseback transaction that qualifies as a sale. IFRS 16 limits the recognition of gains from sale and leaseback transactions. Transition ASC 842 requires a modified retrospective approach to each lease that existed at the beginning of the earliest comparative period presented in the financial statements, as well as leases entered into after that date. IFRS 16 allows a reporting entity to elect a full retrospective approach. Other IFRS 16 has guidance excluding certain leases of low value assets from its recognition and measurement guidance IFRS 16 has similar but not identical disclosure requirements The accounting for subleases differs in some respects 1.2 High-level overview The FASB concluded that a lessee's obligation to make lease payments meets the definition of a liability, as described in FASB Concept Statement No. 6 (CON 6), because it involves a present obligation that arises from a past event and the obligation is expected to result in an outflow of economic benefits. The \"past event\" arises when the lessee signs the lease and the lessor makes the underlying leased asset available to the lessee. The \"present obligation\" arises because the lessee cannot typically avoid making the contractual payments. The boards also believe that a lessee's right to use the underlying asset during the lease term meets the CON 6 definition of an asset. Despite legally owning the asset, the lessor typically cannot use the underlying asset or even access the underlying asset without the lessee's consent. 1-4 PwC Introduction These two conclusions formed the core principles of ASC 842. Excerpt from the Summary of ASU 2016-02 The core principle of Topic 842 is that a lessee should recognize the assets and liabilities that arise from leases. All leases create an asset and a liability for the lessee in accordance with FASB Concepts Statement No. 6, Elements of Financial Statements, and, therefore, recognition of those lease assets and lease liabilities represents an improvement over previous GAAP, which did not require lease assets and lease liabilities to be recognized for most leases. 1.2.1 Definition and scope A lease conveys the right to use an underlying asset for a period of time in exchange for consideration. At the inception of an arrangement, the parties should determine whether the contract contains a lease by assessing both of the following: Whether there is an identified asset Whether the contract conveys the right to control the use of the identified asset in exchange for consideration for a period of time Often, it may be easy to determine that an arrangement contains a lease. Other times, it may be difficult to distinguish between a lease and an arrangement to buy or sell goods or services. See LG 2 for information on evaluating whether an arrangement is a lease. The leasing standard does not require lessees to apply the guidance to arrangements with a lease term of 12 months or less. See LG 2.2.1 for additional information on this short-term lease exception. In addition, certain arrangements are outside the scope of the leasing standard, including: Leases of inventory or of construction in progress Leases of intangible assets, including licenses of internal-use software Leases to explore for or use natural resources Leases of biological assets Service concession arrangements within the scope of ASC 853, Service Concession Arrangements As discussed in LG 7, ASC 842 does not recognize a leveraged lease. Lessors should continue to account for leveraged leases existing at the application date of the leasing standard using the guidance in ASC 840, Leases. PwC 1-5 Introduction 1.2.2 Lessee classification As noted earlier, the FASB decided on a dual model, under which different types of leases have different accounting treatment subsequent to the initial recognition of leased assets and liabilities. The principal distinction between the two types of leases is in the resulting income statement recognition. As discussed in LG 4, a lessee with a finance lease is required to apply a financing model in which the expense resulting from the lease decline during the lease term. Operating leases, on the other hand, result in lease expense recognized on a straight-line basis, by amortizing the leased asset more slowly than a finance leased asset. 1.2.3 Lessor classification Lessors are also required to classify leases. Sales-type and direct financing leases are recognized by a lessor as lease receivables, with interest income that is typically frontloaded (i.e., income per period declines during the lease term). The distinction between a sales-type and a direct financing lease is that in a sales-type lease, the lessee obtains control of the underlying asset the lessor recognizes selling profit and sales revenue upon lease commencement. In order to align lessor accounting with the principles in the revenue recognition guidance in ASC 606, a lessor is precluded from recognizing selling profit or sales revenue at lease commencement for a lease that does not transfer control of the underlying asset to the lessee. An operating lease results in the recognition of lease income on a straight-line basis, while the underlying leased asset remains on the lessor's balance sheet and continues to depreciate. 1.3 Comparison of ASC 842 and ASC 840 The following table summarizes the significant differences between ASC 842 and the previous guidance in ASC 840. 1-6 PwC Introduction Figure 1-2 Changes to lease accounting under ASC 842 Topic ASC 842 guidance Observations Definition of a lease An arrangement contains a lease only when such arrangement conveys the right to \"control\" the use of an \"identified asset\" Under ASC 840, an arrangement can contain a lease even without control of the use of the asset if the customer takes substantially all of the output over the term of the arrangement. Determining whether an arrangement contains a lease is likely to be more important since virtually all leases will require recognition of an asset and liability. It will also make the allocation of contractual consideration between lease and nonlease components a critical element of the accounting analysis for many reporting entities. Lessee accounting The lack of explicit bright lines will increase the level of judgment required when classifying a lease - particularly for certain highly structured transactions. Despite the removal of the bright lines, the guidance in ASC 842-10-55-2 acknowledges that one reasonable approach to determining whether the lease is for a major portion of the asset's life and whether payments represent substantially all of the asset's value is the 75% and 90% thresholds applicable in ASC 840. Lessees will recognize a right-of-use asset and a lease liability for virtually all leases PwC There are no bright lines and there is one additional criterion regarding the specialized nature of the underlying asset for lease classification Putting nearly all leases on the balance sheet is the biggest change, and one of the key objectives of the guidance in ASC 842. 1-7 Introduction Topic Observations Expense will be recognized on a straight-line basis for an operating lease. This is accomplished by increasing the amortization of the right-of-use asset as interest expense on the liability declines over the lease term. Recognition of expense for a finance lease will be similar to capital leases in ASC 840. Lessor accounting ASC 842 guidance Under ASC 840, operating leases are off-balance sheet. Under ASC 842, the accounting for an operating lease will backload amortization of the right-of-use asset, potentially increasing the risk of an impairment. The classification criteria are similar to that for lessees, with an additional requirement to assess collectibility to support classification as a direct financing lease. Also, in order to derecognize the asset and record revenue, collection of payments due must be probable for salestype leases. Under ASC 840, to achieve salestype lease accounting for real estate, title must automatically transfer to the lessee by the end of the lease term. This condition has been removed from the guidance in ASC 842. To recognize upfront revenue and profit in a salestype lease, the lessee will need to obtain control over the leased asset. 1-8 In ASC 840, the difference between a sales-type lease and a direct finance lease is the presence of upfront profit. When present, the arrangement is a sales-type lease. Under ASC 842, the key distinction is based on control. As a practical matter, this will likely depend on whether the lease payments criterion has been met in part due to a third-party residual value guarantee. When this is the case, presuming payments are collectible, the lease is classified as a direct financing lease. PwC Introduction Topic ASC 842 guidance Observations Lease versus nonlease components A contract may contain lease and nonlease components. Under ASC 842, components include only those items or activities that transfer a good or service to the lessee. The right to use land is considered a separate lease component unless the accounting effect of doing so would be immaterial. Under ASC 840, property taxes and insurance are considered executory costs rather than minimum lease payments. Under ASC 842, property taxes and insurance are not considered as components of a contract as they are not for a service provided by the lessor to the lessee and are therefore a part of lease payments. A lessee may choose not to separate nonlease components from their related lease components. If this election is made, all cash flows associated with the nonlease component would be allocated to the related lease component. Under ASC 840, land is separately classified when the fair value of the land is 25% or more of the combined fair value of the land and building. Inception date versus commencement date Under ASC 840, assumptions relevant to classification and measurement are determined at lease inception. Recognition of rent expense or capital lease assets and liabilities begin at the commencement date. Initial direct costs Under ASC 842, initial direct costs are defined as incremental costs of a lease that would not have been incurred if the lease had not been obtained. Under ASC 840, incremental direct costs can include internal costs as well as external costs such as legal fees, even . Certain incremental costs previously eligible for capitalization will be expensed under ASC 842. Build-to-suit arrangements PwC Under ASC 842, the determination of whether or not a contract is a lease or contains a lease is done at the inception date. Lease classification, recognition, and measurement are determined at the lease commencement date. Ownership during construction period based on a control model ASC 840 guidance is based on a risks and rewards model, but contains several complex prescriptive provisions designed to assess lessee ownership during construction. The ASC 842 model has eliminated these prescriptive rules and replaced them with a model based on control. 1-9 Introduction Topic ASC 842 guidance Observations Sale and leaseback transactions Under ASC 842, a sale and leaseback transaction will qualify as a sale only if: Under ASC 840, sale and leaseback accounting is applicable only to lessees. This includes detailed and specialized guidance applicable to sale and leasebacks involving real estate. it meets the sale guidance in the new revenue recognition standard, the leaseback is not a finance lease, and if there is a repurchase option, o o Lessee reassessment 1-10 the repurchase price is at the asset's fair value at the time of exercise and alternative assets that are substantially the same as the transferred asset are readily available in the marketplace. A lessee is required to reassess the lease term if a triggering event occurs that is under the lessee's control or an option is exercisedot exercised as planned. A change to the lease term will lead to a reassessment of lease classification and remeasurement of the lease liability and right-of-use asset. Assumptions such as the discount rate and variable rents based on a rate or index will be updated as of the remeasurement date. Under ASC 842, sale and leaseback accounting will apply to lessees and lessors. A \"failed\" sale is treated as a financing by both the lessee and lessor (i.e., the seller has not sold the asset but has essentially mortgaged it). There is no specialized guidance for sale and leasebacks of real estate. Sale and leaseback transactions involving equipment frequently have fixed price repurchase options - often at the request of the sellerlessee for commercial reasons. Such transactions will not qualify as a sale under the new standard. However, sale and leaseback accounting applied for transactions executed prior to the effective date will not need to be reevaluated. Existing \"failed\" sales will be evaluated under the new standard and may qualify for sale and leaseback accounting on transition. ASC 840 does not require a reassessment of lease classification unless the lease is modified or an option is exercised. Under ASC 842, a lessee will need to monitor for triggering events on an ongoing basis. PwC Introduction Topic Observations Modification 1.4 ASC 842 guidance A lease modification is a change to the contractual terms and conditions of a lease that was not part of the original lease and which results in a change in scope or consideration. A modification that grants the lessee an additional right of use priced at market is a separate lease that is then classified at the lease modification date. Lease modifications under ASC 840 can be very complex and difficult to differentiate a termination of a lease co A renewal or considered a new changes are subject two-step evaluation of the Disclosures The leasing standard includes extensive disclosure requirements intended to enable users of financial statements to understand the amount, timing, and judgments related to a reporting entity's accounting for leases and the related cash flows. The leasing standard requires disclosure of both qualitative and quantit