14.3 Lessor
14.3.1 Sales-Type and Direct Financing Leases
14.3.1.1 Statement of Financial Position
ASC 842-30
Sales-Type and Direct Financing Leases
Statement of Financial Position
45-1 A lessor shall present lease assets (that is, the aggregate of the lessor’s net investment in sales-type leases and direct financing leases) separately from other assets in the statement of financial position.
45-2 Lease assets shall be subject to the same considerations as other assets in classification as current or noncurrent assets in a classified balance sheet.
As noted above, “the aggregate of the lessor’s net investment in sales-type
leases and direct financing leases” must be presented “separately from other
assets in the statement of financial position.” In other words, these
balances must be presented discretely in the statement of financial position
and cannot be combined with other financial statement balances.
When presenting a classified balance sheet, a lessor must
classify its net investments in leases as current and noncurrent. While a
lessee does not need to present its ROU assets as current and noncurrent,
the same logic cannot be applied to a lessor’s net investment in the lease.
The net investment in a lease is a financial asset that is within the scope
of ASC 310; therefore, there is often a current balance, the amount that is
reasonably expected to be realized in cash during the normal operating cycle
of the business.
14.3.1.2 Statement of Comprehensive Income
ASC 842-30
Statement of Comprehensive Income
45-3 A lessor shall either present in the statement of comprehensive income or disclose in the notes income arising from leases. If a lessor does not separately present lease income in the statement of comprehensive income, the lessor shall disclose which line items include lease income in the statement of comprehensive income.
45-4 A lessor shall present any profit or loss on the lease recognized at the commencement date in a manner that best reflects the lessor’s business model(s). Examples of presentation include the following:
- If a lessor uses leases as an alternative means of realizing value from the goods that it would otherwise sell, the lessor shall present revenue and cost of goods sold relating to its leasing activities in separate line items so that income and expenses from sold and leased items are presented consistently. Revenue recognized is the lesser of:
- The fair value of the underlying asset at the commencement date
- The sum of the lease receivable and any lease payments prepaid by the lessee.
Cost of goods sold is the carrying amount of the underlying asset at the commencement date minus the unguaranteed residual asset. - If a lessor uses leases for the purposes of providing finance, the lessor shall present the profit or loss in a single line item.
Any income from sales-type leases (selling profit or loss and interest income)
or direct financing leases (interest income) must be included in the
statement of comprehensive income. To the extent that the amounts are not
presented separately, they should be disclosed in the notes to the financial
statements. See the Connecting the Dots in Section 14.2.2.1 for a discussion of
the presentation of income from variable lease payments.
Connecting the Dots
SEC Regulation S-X
Requirements Related to Income Statement
Presentation
SEC Regulation S-X, Rule 5-03, indicates the various
line items that should appear on the face of the income statement.
Specifically, a registrant should separately present any amounts
that represent 10 percent of the sum of income derived from net
sales of tangible products, operating revenues from public utilities
or others, income from rentals, revenues from services, and other
revenues. Although these SEC Regulation S-X requirements do not
appear to mandate any disclosures that are not already prescribed by
ASC 842, registrants should nonetheless consider the rule’s mandates
in evaluating whether separate presentation on the face of the
financial statements is warranted.
Revenue
Recognized
ASC 842-30-45-4(a) states that revenue recognized by
a lessor that “uses leases as an alternative means of realizing
value from the goods that it would otherwise sell” must be the
lesser of (1) the “fair value of the underlying asset at the
commencement date” or (2) the “sum of the lease receivable and any
lease payments prepaid by the lessee.” The intent of this guidance
is to ensure that a lessor reflects the substance of its
transactions — as either a seller or financier of a good —
regardless of whether the lease is a sales-type lease in form. It
would be more appropriate for a seller of a good to present the
gross sales proceeds and cost of the good sold, whereas a financier
may only present profit and interest income.
Example 14-4
Case A
One of Loman Inc.’s traveling salespeople enters into an arrangement to lease
props and other theater equipment to a customer,
Miller Theater Company. Although Loman typically
sells its equipment, Miller prefers to enter into a
lease because the lease requires payment streams
that are preferable to the full up-front selling
price. Loman determines that the lease is a
sales-type lease. The fair value of the theater
equipment is $10,000, and Loman’s cost is $8,000.
The appropriate income statement presentation of Loman sales-type lease at
commencement is:
Case B
Assume the same facts as in Case A except that Loman Inc. is a financial institution and provides financing to various customers to purchase equipment. In this case, Loman uses leasing as a means of providing financing to customers rather than selling its assets. The only amount presented in the financial statements at commencement would be selling profit of $2,000 (the net effect of the prior calculated balances — that is, the net impact of $10,000 less $8,000). (Note that with the changes to the lessor’s lease classification, it is possible for a financier to obtain sales-type lease classification — see Section 9.2.)
14.3.1.2.1 Presentation of Sublease Income
The ASC master glossary defines a sublease as “[a]
transaction in which an underlying asset is re-leased by the lessee (or
intermediate lessor) to a third party (the sublessee) and the original
(or head) lease between the lessor and the lessee remains in effect.”
From a balance sheet perspective, subleases generally must be presented
on a gross basis since they do not relieve the sublessor’s legal
obligation under the head lease. However, ASC 842 does not directly
address income statement presentation of subleases. While the amounts
paid to the original, third-party lessor are generally presented in the
income statement as a component of selling, general, and administrative
expenses or as part of cost of goods sold, questions have arisen
regarding how sublease income should be presented under ASC 842 — that
is, whether it would be appropriate to recognize sublease income on a
net basis (i.e., as an offset to the head lease expense) rather than on
a gross basis.
ASC 842 does not explicitly indicate whether it would be
acceptable to net, for income statement presentation purposes, sublease
income against the related head lease expense. Because subleases
generally must be presented on the balance sheet on a gross basis under
ASC 842, one might conclude that gross income statement presentation is
required as well. However, we believe that net presentation of sublease
activity in the income statement may be appropriate when the sublease
activity is outside an entity’s normal business operations (and thus
occurs infrequently) and when doing so would result in more meaningful
financial reporting information for financial statement users. For
example, in some instances, net presentation may better reflect the true
cost of leasing the underlying asset or may avoid distortion of
important financial statement metrics such as operating income (e.g.,
scenarios in which the recognition of the sublease income and head lease
expense on a gross basis would understate total operating income because
the sublease income would be recognized as a component of “other
income/expense (net)”). In such circumstances, net presentation within
selling, general, and administrative expenses or cost of goods sold may
be appropriate.
14.3.1.3 Statement of Cash Flows
ASC 842-30
Statement of Cash Flows
45-5 In the statement of cash
flows, a lessor shall classify cash receipts from
leases within operating activities. However, if the
lessor is within the scope of Topic 942 on financial
services — depository and lending, it shall follow
the guidance in paragraph 942-230-45-4 for the
presentation of principal payments received from
leases.
The guidance in ASC 842-30-45-5, as originally issued, was clear that cash
receipts from sales-type leases or direct financing leases are included in
operating activities in the statement of cash flows. However, the FASB staff
received questions from stakeholders because the example in ASC 942-230-55-2
conflicted with the guidance in ASC 842-30-45-5, as originally issued.
Specifically, the example in ASC 942 illustrates the direct method of cash
flows and presents “principal payments received under leases” in cash flows
from investing activities. (This example existed before, and was not
consequentially amended by, the issuance of ASC 842.) Accordingly, in March
2019, the Board issued ASU 2019-01, which addresses this
conflicting guidance by retaining the current guidance in ASC 942. Thus,
depository and lending lessors (those entities within the scope of ASC 942)
should continue to classify principal payments received from sales-type and
direct financing leases within “investing activities.” See Section 17.3.1.7 for
a detailed discussion of ASU 2019-01.
14.3.2 Operating Leases
14.3.2.1 Statement of Financial Position
ASC 842-30
Statement of Financial Position
45-6 A lessor shall present the underlying asset subject to an operating lease in accordance with other Topics.
Because a lessor’s operating lease does not result in derecognition of the underlying asset, the lessor should present the underlying asset in accordance with other U.S. GAAP (e.g., ASC 360 on PP&E). Although there is no prescriptive guidance on presenting deferred rent balances (i.e., straight-line rent), an entity should present such balances in accordance with ASC 210.
14.3.2.2 Statement of Comprehensive Income
See ASC 842-30-45-3 for the discussion of the statement of comprehensive income
in Section
14.3.1. The same guidance would apply to a lessor’s operating
leases.
Connecting the Dots
Presentation of Lease Revenue and Tenant Reimbursements in the
Financial Statements
As discussed in Section
4.4.1.1, in a typical gross lease of real estate, the
lessee pays a single fixed payment that covers rent, property taxes,
insurance, and CAM. The portion of the single fixed payment
attributable to property taxes, insurance, and CAM has historically
been presented by real estate lessors as “tenant reimbursements,” a
separate revenue line item in a lessor’s income statement. Under ASC
842, CAM is considered a nonlease component (see Section 4.3.1) whereas
reimbursements for property taxes and insurance are noncomponents
(see Section 4.3.2). Nonlease
components are separated from lease components and are generally
accounted for in accordance with ASC 606 unless the lessor qualifies
for and elects the practical expedient related to combining the
components (see Section
4.3.3.2). Furthermore, as discussed in Section 4.3.2, consideration in the
contract is not allocated to noncomponents because they do not
transfer a good or service to the lessee. Consideration for
noncomponents is deemed part of the overall consideration in the
contract, which is allocated to lease and nonlease components on a
relative stand-alone selling price basis.
If a lessor elects the practical expedient in ASU 2018-11 (discussed
in Section 4.3.3.2) and
therefore combines lease and associated nonlease components
(provided that certain criteria are met), the lessor should present
a single rental revenue line item (as long as the lease component is
predominant2) that includes the combined lease and nonlease components.
However, if a lessor does not qualify for or elect the practical
expedient, it should present the lease and nonlease components
separately. The resulting separate presentation typically will not
be aligned with the historical presentation when the Comparatives
Under 840 Option is elected.
Example 14-5
Lessor and Lessee enter into a five-year lease of a
floor in an office building. The contract stipulates
that Lessee is required to reimburse Lessor for the
costs related to the asset, including the real
estate taxes and Lessor’s performance of CAM at the
building. The lease commences on March 1, 2016.
Lessor’s ASC 842 adoption date will be January 1,
2019, and it will elect the transition relief under
ASU 2018-11 (i.e., the Comparatives Under 840 Option
— see Section
16.1.1) and thus will not be recasting
prior periods.
Lessee’s total
payments for 2016–2018 are as follows:
Presentation Under ASC 840 for Year Ended December
31, 2018
Many real estate lessors have historically presented
the revenue components for this type of lease
agreement in two separate revenue line items in the
income statement. The two separate line items are
usually titled “Rental Revenue” and “Tenant
Reimbursement Revenue.”
Sample Presentation Under ASC 842
for Year Ended December 31, 2019
If Lessor elects the practical expedient related to
not separating lease and nonlease components
(provided that the lease meets the criteria under
ASU 2018-11), rental revenue (the lease component)
and CAM (the nonlease component(s)) should be
presented in a single line item in the financial
statements (i.e., rental revenues), beginning in the
year of adoption.
The following is a
sample presentation if Lessor elects the practical
expedient under ASU 2018-11 (in this example, it is
assumed that 2019 gross lease payments are the same
as those for 2018):
If Lessor does not elect the practical expedient,
lease and nonlease components would be presented
separately in the income statement. Lease components
are accounted for under ASC 842, while nonlease
components are accounted for in accordance with
other U.S. GAAP (typically ASC 606). Assume that the
stand-alone selling prices for the lease of the
underlying asset and maintenance services are
$50,000 and $8,000, respectively. The property taxes
paid by Lessee are a noncomponent, and no
consideration would be allocated to the
noncomponents. The total consideration would be
allocated between the lease component and the
nonlease component on the basis of the stand-alone
selling price.3
The table below
illustrates a sample presentation if Lessor does not
elect the practical expedient under ASU 2018-11.
Note that while we believe that the income statement presentation of “tenant
reimbursements” will change from historical practice (as described above),
we understand that many real estate lessors will want to continue providing
this information given the performance metrics used by analysts that cover
the sector. Lessors that wish to disclose such information in the financial
statement footnotes should work with their auditors to develop appropriate
disclosures and, in doing so, should take into consideration the rules
related to non-GAAP measures.
14.3.2.3 Statement of Cash Flows
ASC 842-30
45-7 In the statement of cash flows, a lessor shall classify cash receipts from leases within operating activities.
Cash receipts from operating leases are included in operating activities in the statement of cash flows.
Footnotes
2
See Section 4.3.3.2.2
for further discussion of how an entity determines which
component is predominant when applying the lessor practical
expedient to combine lease and nonlease components.
3
The allocation of the total
consideration in this example is calculated as
follows (see Section
4.4 for further details on allocating
consideration in a contract.