Chapter 14 — Presentation | DART – Deloitte Accounting Research Tool

Chapter 14 — Presentation

14.1 Overview

14.2 Lessee

14.2.1 Statement of Financial Position

14.2.2 Statement of Comprehensive Income

14.2.3 Statement of Cash Flows

14.3 Lessor

14.3.1 Sales-Type and Direct Financing Leases

14.3.2 Operating Leases

14.1 Overview

Concerns about the lease presentation requirements in ASC 840, particularly those for lessees, provided the impetus for the issuance of ASC 842. Specifically, in developing ASC 842, the FASB decided to remove the classification disparity between operating leases and capital leases, bring all leases onto the balance sheet, and require lessees to recognize lease assets and lease liabilities in the statement of financial position. As indicated in the summary portion of ASU 2016-02, the primary objective of the new presentation requirements is to increase financial statement transparency and give users a more “complete and understandable picture of an entity’s leasing activities.”

Below is a more detailed discussion of ASC 842’s financial statement presentation requirements for both lessees and lessors.

14.2 Lessee

14.2.1 Statement of Financial Position

ASC 842-20

Statement of Financial Position

45-1 A lessee shall either present in the statement of financial position or disclose in the notes all of the following:

Finance lease right-of-use assets and operating lease right-of-use assets separately from each other and from other assets
Finance lease liabilities and operating lease liabilities separately from each other and from other liabilities. . . .

45-2 If a lessee does not present finance lease and operating lease right-of-use assets and lease liabilities separately in the statement of financial position, the lessee shall disclose which line items in the statement of financial position include those right-of-use assets and lease liabilities.

45-3 In the statement of financial position, a lessee is prohibited from presenting both of the following:

Finance lease right-of-use assets in the same line item as operating lease right-of-use assets
Finance lease liabilities in the same line item as operating lease liabilities.

A lessee must present in the statement of financial position (or disclose in the notes thereto) (1) finance lease ROU assets separately from operating lease ROU assets and (2) finance lease liabilities separately from operating lease liabilities. The rationale for separate presentation is that the lease classifications differ with respect to the subsequent-measurement patterns for their respective assets and, in the Board’s view, represent economically different transactions. In addition, as discussed in paragraph BC57 of ASU 2016-02, finance lease liabilities may not be presented with operating liabilities because finance lease liabilities are the equivalent of debt and are generally treated as such in the event of an entity’s bankruptcy. ASC 842 does not specifically prescribe which financial statement line item is appropriate for presentation (e.g., separate presentation of finance-lease ROU assets in a PP&E financial statement line item).

Connecting the Dots

Balance Sheet Presentation Is Favorable for Debt Covenants

Preparers may be in favor of the requirement to present finance leases separately from operating leases because this requirement may reduce an entity’s exposure to potential debt covenant violations that could have resulted if the entity was required to characterize all lease liabilities as debt. See the Connecting the Dots in Section 8.1.1 for more information.

While the standard does not require distinct presentation on the face of the statement of financial position, the assets and liabilities related to each lease classification must be presented separately (i.e., in either distinct or separate financial statement line items). A lessee that discloses the amounts in the notes must also disclose in which financial statement line items the amounts are included in the statement of financial position.

Connecting the Dots

SEC Regulation S-X Requirements Related to Separate Presentation of Assets and Liabilities

SEC Regulation S-X, Rule 5-02, requires registrants to separately present, in the balance sheet or a note thereto, (1) “other assets” that are in excess of 5 percent of total assets and (2) any item in excess of 5 percent of other current liabilities and any other liability in excess of 5 percent of total liabilities. Although these SEC Regulation S-X requirements do not appear to mandate any disclosures that are not already prescribed by ASC 842, companies should nonetheless consider the requirements in evaluating whether separate presentation on the face of the financial statements is warranted.

When a lease arrangement would result in a negative ROU asset balance as of the commencement date, the lessee should reduce the ROU asset down to zero and recognize the difference as a liability, because it would be inappropriate to recognize a negative ROU asset. For more information, see Section 8.4.2.3.

14.2.1.1 Considerations Related to Presentation of ROU Assets and Lease Liabilities in a Classified Statement of Financial Position

ASC 842-20

Statement of Financial Position

45-1 . . . Right-of-use assets and lease liabilities shall be subject to the same considerations as other nonfinancial assets and financial liabilities in classifying them as current and noncurrent in classified statements of financial position.

14.2.1.1.1 Presentation of ROU Assets in a Classified Statement of Financial Position

As stated above in ASC 842-20-45-1, the ROU asset “shall be subject to the same considerations as other nonfinancial assets . . . in classifying them as current and noncurrent in classified statements of financial position.” Therefore, an entity that presents a classified balance sheet is not required to classify its ROU assets as current and noncurrent. Entities typically exclude depreciated or amortized assets (e.g., PP&E and intangible assets, respectively) from current assets in accordance with ASC 210-10-45-4(f). Under ASC 842, ROU assets must be amortized and are therefore akin to other amortizable assets.

14.2.1.1.2 Presentation of Lease Liabilities in a Classified Statement of Financial Position

As stated above in ASC 842-20-45-1, “lease liabilities shall be subject to the same considerations as other . . . financial liabilities in classifying them as current and noncurrent in classified statements of financial position.” Therefore, an entity that presents a classified balance sheet must classify its lease liabilities as current and noncurrent. ASC 210-10-45-6 states, in part, that the “concept of current liabilities includes estimated or accrued amounts that are expected to be required to cover expenditures within the year for known obligations.” Therefore, an entity should classify the portion of its lease liabilities that it expects to be required to pay within the year (or the entity’s operating cycle) as a current liability.

As illustrated in the example below, the calculation of the current portion of the liability includes the portion of the lease payments that will be applied to the liability’s principal over the next 12 months. This observation is consistent with the guidance in ASC 210-10-45-9, which states, in part, that current liabilities should include “[o]ther liabilities whose regular and ordinary liquidation is expected to occur within a relatively short period of time, usually 12 months.”

Example 14-1

On December 31, 20X2, Company X, a lessee, commenced a lease with a term of three years and an annual lease payment of $4,660 due on each anniversary of the commencement date. Company X uses a year (12 months) to classify other current assets and liabilities in its classified balance sheet in accordance with ASC 210. After discounting the lease payments at a discount rate of 8 percent, X determines that (1) its total lease liability is $12,009 and (2) $3,699 of the liability will be paid within one year from the balance sheet date. As of December 31, 20X2, X classifies $3,699 as a current liability and the remaining $8,310 as a noncurrent liability when it presents its classified balance sheet.

The table below illustrates the calculation of the current liability in each year of the lease term by using an approach in which the current portion of the liability is equal to the payment amount to be applied to the liability’s principal.

Another acceptable approach for calculating the current portion of a lease liability may be to include the present value of the lease payment(s) scheduled to be made over the next 12 months.

In addition to the approaches described above, we are aware of certain alternatives that entities may apply in determining the current portion of the lease liability. We recommend that entities consult with their accounting advisers in evaluating the reasonableness of any alternative applied.

14.2.1.1.3 Considerations When the Current Portion of a Lease Liability Would Be Negative

Section 6.2.2 discusses certain lease agreements that may include provisions requiring lessors to make payments to lessees during the lease term (e.g., contractual lease incentives in the form of reimbursements for leasehold improvements). These lease incentives reduce a lessee’s total lease payments during the lease term. In some circumstances, for example, when in conjunction with a rent-free period at the beginning of a lease, it is possible that a lessee could expect to receive lease incentives within one year from the balance sheet date that exceed the fixed rental payments (i.e., outflows) due within that same period, resulting in a net cash inflow for the next 12 months of the lease term. ASC 842-20-45-1 states that “lease liabilities shall be subject to the same considerations as other . . . financial liabilities in classifying them as current and noncurrent in classified statements of financial position.” However, there is limited guidance in other GAAP that applies to the classification of a financial liability with a current portion that is a net cash inflow in the next 12 months.

In these situations, there is diversity in practice. We are aware of the following two approaches that entities have applied in such circumstances:

Noncurrent lease liability — Under this common approach, an entity presents the entire lease liability, including the net cash inflow in the next 12 months, as a noncurrent lease liability. As discussed in Sections 6.2.2 and 8.5.4.3, lease incentives to be received during the lease term are lease payments that entities may treat1 as reductions of the lease liability. Because a lease arrangement is a single contract, the associated lease liability may be considered a single unit of account; accordingly, it is acceptable to present the lease liability as a single noncurrent lease liability even when the next 12 months are expected to yield a net cash inflow (i.e., representing a present right to receive cash). Supporters of this view believe that the arrangement is analogous to an unexercised draw-down of future debt in a manner consistent with the presentation guidance in ASC 842-20-45-1, which states that the “lease liabilities shall be subject to the same considerations as other . . . financial liabilities.” Accordingly, proponents of this view think that it is appropriate to present a lower noncurrent liability as of the balance sheet date since the lease liability is a single unit of account that, like a financial liability, the entity has the intent to repay over a term greater than 12 months and for which the obligation to repay that higher amount over the long term has not yet occurred. That is, when the cash is received, the noncurrent (financial) liability will increase to the amount of the expected future cash flows calculated in the lease’s amortization table.
Present current portion (to be received) as a current receivable — Another acceptable approach in our view is one in which an entity presents cash flows representing the current portion (i.e., the net cash inflow for the next 12 months) as a current asset (receivable). The ASC master glossary defines current assets as “other assets or resources commonly identified as those that are reasonably expected to be realized in cash or sold or consumed during the normal operating cycle of the business.” This definition supports the view that entities that are party to these leasing arrangements have a contractual right to receive cash in the normal operating cycle (i.e., within the next 12 months) and may record a current asset that provides a faithful representation of liquidity for the next 12 months. This view is similar to our views on classifying derivatives in hedging relationships with multiple settlements. That is, we believe that the amounts related to (all) the cash flows that must occur within one year of the balance sheet date would represent the current asset or current liability (see Section 6.2.2 of Deloitte’s Roadmap Hedge Accounting for more information).

We do not believe that it would be appropriate for a lessee to net the current receivable associated with one lease arrangement against other short-term lease liabilities from other lease contracts. In other words, when applying the current receivable approach, an entity must present an asset as current either separately or within an appropriate asset category. Also, in both approaches, entities must present a current portion of a lease liability in accordance with the approach outlined in Section 14.2.1.1.2 once there is no longer a net cash inflow under the lease arrangement for the next 12 months.

The example below illustrates a leasing arrangement in which a lessee must determine the classification of a lease liability that includes lease incentives to be received in the next 12 months in excess of fixed rental payments (i.e., outflows) to be made to the lessor in the next 12 months (i.e., the current portion is a net cash inflow).

Example 14-2

Company A (Lessee) is party to a 10-year lease for an office building with Landlord B (Lessor). The lease commencement date is July 1, 20X1. The lease contains an 18-month free rent holiday between July 1, 20X1, and December 31, 20X2; accordingly, fixed rental payments commence on January 1, 20X3, and continue until the end of the lease term. As an incentive for signing the lease, Lessor will provide Lessee with $10 million in reimbursements for leasehold improvements that Lessee is planning on making to the property. While Lessee must submit receipts for eligible expenditures to Lessor on or before June 31, 20X2 (for payment on July 15, 20X2), Lessee has an expenditure budget greater than $15 million and, upon lease commencement, has determined that it is probable that it will receive the entire $10 million lease improvement allowance. Further, Lessee has elected a policy of including the leasehold improvement allowance in the measurement of the lease liability upon commencement. Assume that other than fixed rental payments commencing on January 1, 20X3, and the leasehold improvement allowance to be received by Lessee, no other lease payments are included in the contract.

As of lease commencement, Lessee has concluded the following:

The reimbursements received from Lessor represent lease incentives for leasehold improvements (rather than reimbursements for landlord-owned assets).
Lessee is reasonably certain to complete the construction of leasehold improvements and receive 100 percent of the $10 million of reimbursements on July 15, 20X2. In a manner consistent with the discussion in Section 8.5.4.3, Lessee elects an accounting policy of including the lease incentive of $10 million within lease payments. Because Lessee believes that it is probable at lease commencement that the payments will be received, there is a reduction in the ROU asset and the lease liability.
The lease is classified as an operating lease.

During the initial 18-month “free” rent period, the lease contract does not require Lessee to make rental payments to Lessor, and the only lease payment included in the measurement of the lease liability is the $10 million lease incentive expected to be received (a cash inflow to Lessee) on July 15, 20X2, which results in a net cash inflow as of December 31, 20X1. In preparing the annual financial statements as of December 31, 20X1, Lessee may present the entire lease liability — including the measurement of (1) the $10 million lease incentive receivable and (2) all contractual fixed rent payments commencing on January 1, 20X3, and through the end of the lease term — as a noncurrent lease liability.

It would also be acceptable for Lessee to present the measurement of the net cash inflow in the next 12 months (i.e., the $10 million lease incentive) as a current receivable and to separately present, as a noncurrent lease liability, the measurement of the combined contractual fixed rent payments commencing on January 1, 20X3, and continuing through the end of the lease term.

We believe that an entity may also apply the second presentation approach discussed above (i.e., presentation of negative lease liability as a receivable) when determining financial statement presentation for lease arrangements that result in the recognition of a negative lease liability at lease commencement. For example, a lease arrangement with a payment structure in which the fixed lease payments are minimal or zero, and that also includes fixed lease incentives receivable from the lessor during the lease term, would result in a negative lease liability at lease commencement.

As discussed above, because of the complexities associated with such lease arrangements, we recommend that entities consult with their accounting advisers and auditors when establishing an acceptable policy in such situations.

14.2.2 Statement of Comprehensive Income

ASC 842-20

Statement of Comprehensive Income

45-4 In the statement of comprehensive income, a lessee shall present both of the following:

For finance leases, the interest expense on the lease liability and amortization of the right-of-use asset are not required to be presented as separate line items and shall be presented in a manner consistent with how the entity presents other interest expense and depreciation or amortization of similar assets, respectively
For operating leases, lease expense shall be included in the lessee’s income from continuing operations.

14.2.2.1 Finance Leases — Presentation of Interest Expense on the Lease Liability and Amortization Expense Related to the ROU Asset

The requirements for finance leases in ASC 842-20-45-4(a) with respect to presentation of interest expense and amortization expense are in line with the FASB’s view that a finance lease is economically similar to a financed asset purchase (i.e., the proceeds of a loan used to acquire an asset). Therefore, in a manner consistent with a financed purchase transaction, an entity would incur interest expense on its financing (loan) and would depreciate its asset acquired.

Connecting the Dots

Variable Lease Payments in Finance Leases (or Sales-Type Leases and Direct Financing Leases)

ASC 842 is silent on the appropriate classification of variable lease expense arising from finance leases. Many preparers have asked whether such expense should be recognized as amortization, interest expense, or lease expense (in a manner similar to recognition of an operating lease expense). Because of the variable and often contingent nature of such expense and its exclusion from the balance sheet ROU asset and liability, it does not involve the amortization of an asset or, similarly, the accrual of interest against a liability balance. Therefore, questions have arisen about how this expense should be recognized once the variability or contingency is resolved (or is deemed probable in accordance with ASC 842-20-55-1) and recognized as an expense (see Section 8.5.4 for a detailed discussion of a change in lease payments resulting from the resolution of a contingency).

Paragraph BC271 of ASU 2016-02 states:

[T]he Board decided that cash flows from operating leases and variable lease payments that are not included in the lease liability should be classified as operating activities because the corresponding lease costs, if recognized in the statement of comprehensive income, will be presented in income from continuing operations. The previous sentence notwithstanding, Topic 842 states that lease payments capitalized as part of the cost of another asset (for example, inventory or a piece of property, plant or equipment) should be classified in the same manner as other payments for that asset. [Emphasis added]

Paragraph BC271 of ASU 2016-02 seems to indicate that, from the lessee’s perspective, variable lease payments would be recognized in income from continuing operations in a manner similar to operating lease expense. (By analogy, this could also mean that variable lease payments from sales-type or direct financing leases should be recognized as a component of income from continuing operations, rather than as interest income.) Therefore, we believe that there is a basis for presenting variable lease expense as lease expense (i.e., instead of as amortization or interest).

However, we would accept presentation of variable lease expense in the statement of comprehensive income as either (1) interest expense or (2) a component of income from continuing operations (e.g., lease expense). (Similarly, we believe that lessors could present variable lease income related to payments that are not included in the initial measurement of a net investment in a sales-type or direct financing lease as either interest income or lease income.) Entities should disclose their presentation approach, if material.

14.2.2.2 Operating Leases — A Single Lease Expense

A lessee should evaluate its lease cost and, in a manner consistent with other types of expenses, should classify the single lease expense as cost of sales; selling, general, and administrative expenses; or another operating expense line item in the entity’s statement of comprehensive income.

14.2.2.2.1 Presentation of Lease Expense for Operating Leases With Impaired ROU Assets

As discussed in Section 8.4.4, when recognizing an impairment of an ROU asset associated with an operating lease, a lessee subsequently amortizes the ROU asset by using a finance lease model approach (i.e., the ROU asset is amortized on a straight-line basis, and incremental expense is recognized under the effective interest method). In accordance with ASC 842-20-25-7, while the recognition pattern changes for operating leases after impairment (i.e., the finance lease exhibits a “front-loaded” expense profile because a higher liability corresponds to higher interest in earlier periods of the lease coupled with a straight-line amortization of the ROU asset), the character of the expense does not. Specifically, ASC 842-20-25-7 states:

After a right-of-use asset has been impaired in accordance with paragraph 842-20-35-9, the single lease cost described in paragraph 842-20-25-6(a) shall be calculated as the sum of the following:

Amortization of the remaining balance of the right-of-use asset after the impairment on a straight-line basis, unless another systematic basis is more representative of the pattern in which the lessee expects to consume the remaining economic benefits from its right to use the underlying asset
Accretion of the lease liability, determined for each remaining period during the lease term as the amount that produces a constant periodic discount rate on the remaining balance of the liability.

Despite the different pattern of expense recognition after impairment, a lessee should not separately present its expense incurred between interest expense and amortization of the ROU asset. Rather, these expenses must continue to be presented as a “single” lease expense and must be included in the lessee’s income from continuing operations in a manner consistent with its operating lease classification.

14.2.2.2.2 Presentation of Lease Expense for Operating Leases Subject to Abandonment Accounting

As discussed in Section 8.4.4.1, for an operating lease subject to an abandonment plan, an entity may either (1) fully amortize the remaining balance of the ROU by the planned abandonment date (i.e., over the shortened useful life) on a straight-line basis or (2) retain an overall straight-line expense profile for the period between the date on which a decision is made regarding the abandonment and the actual abandonment date.

Neither of the approaches described above retains a straight-line expense profile over the full remaining term of the lease. While the pattern of expense recognition over the remaining lease term of an operating lease subject to an abandonment plan deviates from a “standard” straight-line recognition pattern otherwise applicable to operating leases, we believe that an operating lessee should continue to present a “single” lease expense after the abandonment decision date in the income statement in a manner consistent with, and within the same financial statement line item as, the presentation of the expense before the abandonment decision date.

14.2.2.2.3 Presentation of Gain or Loss Upon Early Termination of an Operating Lease

When a lessee recognizes a gain or loss upon the early termination of an operating lease, the lessee should present that gain or loss within the “single” lease expense in the operating lessee’s income from continuing operations.

14.2.3 Statement of Cash Flows

ASC 842-20

Statement of Cash Flows

45-5 In the statement of cash flows, a lessee shall classify all of the following:

Repayments of the principal portion of the lease liability arising from finance leases within financing activities
Interest on the lease liability arising from finance leases in accordance with the requirements relating to interest paid in Topic 230 on cash flows
Payments arising from operating leases within operating activities, except to the extent that those payments represent costs to bring another asset to the condition and location necessary for its intended use, which should be classified within investing activities
Variable lease payments and short-term lease payments not included in the lease liability within operating activities.

Upon commencement of an operating lease, a lessee records an ROU asset and a lease liability. Such noncash activity should be disclosed (see Section 15.2.4.8). For operating leases, repayments of liabilities should be classified in operating activities. Similarly, in a manner consistent with the income statement presentation discussed in Section 14.2.2, when a lessee recognizes a gain or loss upon the early termination of an operating lease, the lessee should present that activity within operating activities in the statement of cash flows. If any payments made for operating leases represent the costs of bringing another asset to the condition and location necessary for its intended use, such amounts should be classified as investing activities.

Upon commencement of a finance lease, a lessee records an ROU asset and lease liability. The noncash activities will be reflected in the noncash investing and financing disclosures (see Section 15.2.4.8). Such noncash activity should be included in the investing and financing activities sections of the statement of cash flows for the asset and liability, respectively. This is consistent with the guidance in ASC 230-10-50-4, which states:

Examples of noncash investing and financing transactions are converting debt to equity; acquiring assets by assuming directly related liabilities, such as purchasing a building by incurring a mortgage to the seller; obtaining a right-of-use asset in exchange for a lease liability; obtaining a beneficial interest as consideration for transferring financial assets (excluding cash), including the transferor’s trade receivables, in a securitization transaction; obtaining a building or investment asset by receiving a gift; and exchanging noncash assets or liabilities for other noncash assets or liabilities. [Emphasis added]

In addition to noncash disclosures associated with the initial recognition of a lease, a lessee should also consider noncash disclosure requirements based on other noncash changes (increases or decreases) to the lease balances, such as those resulting from lease modifications or reassessment events.

When the lessee makes lease payments under a finance lease, the lessee should reflect the principal portion of the payments as a cash outflow from a financing activity in the statement of cash flows. The portion of finance lease payment that reflects the interest payment should be classified as a cash outflow from an operating activity.

The example below illustrates the financial statement presentation for a finance lease and operating lease.

Example 14-3

A lessee enters into a three-year lease and agrees to make the following annual payments at the end of each year: $10,000 in year 1, $15,000 in year 2, and $20,000 in year 3. The initial measurement of the ROU asset and liability to make lease payments is $38,000 at a discount rate of 8 percent.

This table highlights the differences in accounting for the lease as a finance lease and an operating lease:

For the finance lease model, the interest expense calculated is a function of the lease liability balance and the discount rate (i.e., $38,000 multiplied by 8 percent in year 1). For the finance lease, the lessee includes amortization expense as a noncash add-back to the operating activities section of the statement of cash flows, which is calculated on a straight-line basis ($38,000 divided by 3). The principal portion of the cash payment is reflected in the financing section as principal paid. There is no need to separately add interest expense since it is already included in net income in the operating section. The supplemental section includes interest paid.

For the operating lease model, the lessee may include noncash lease expense as a noncash add-back to the operating section of the statement of cash flows ($15,000 – $3,038 = $11,962); this reflects the portion of the lease expense that amortized the ROU asset. While this presentation reflects a best practice, there may be other acceptable methods of presentation for the change in ROU assets; however, it would be inappropriate to present the change in ROU assets in amortization expense. Entities contemplating a different method of presentation are encouraged to discuss the method with their accounting advisers. The cash payment is reflected in the operating section as a change in operating liabilities. Because interest expense is not included in operating leases, there are no separate disclosures for this activity.

Footnotes

If the lease payments to be received during the lease term are fixed, they must be treated as reductions to the lease liability. However as described in Section 8.5.4.3, lessees that receive lease incentives during the term that are based on the resolution of future contingencies may elect to include lease payments in the measurement of the lease liability at lease commencement if the receipt of those incentives from the lessor is probable at lease commencement.

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:
1. The fair value of the underlying asset at the commencement date
2. 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’s 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.” See Chapter 12 for additional guidance on accounting for sublease arrangements.

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 E.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.

Lessors must defer initial direct costs associated with operating leases as a separate asset as of the commencement date and must recognize these costs as an expense over the lease term on the same basis as lease income (see Section 9.3.9.1). However, ASC 842 does not explicitly discuss whether the deferred initial direct costs should be presented as a current or noncurrent asset. Accordingly, we believe that either presentation is acceptable, provided that it is applied consistently as an accounting policy. Since the above approaches for presenting a lessor’s deferred initial direct costs are also acceptable for classifying capitalized contract costs under ASC 606 (see Section 14.6.3 of Deloitte’s Roadmap Revenue Recognition), an entity may find it useful to apply its selected presentation approach consistently to deferred initial direct costs and capitalized contract costs.

14.3.2.2 Statement of Comprehensive Income

The guidance on the statement of comprehensive income that applies to a lessor’s operating leases is the same as that in ASC 842-30-45-3 (see Section 14.3.1.2).

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. Under ASC 840, the portion of the single fixed payment attributable to property taxes, insurance, and CAM was 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 under ASC 840.

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 January 1, 20X1.

Lessee’s total payments for the year ended December 31, 20X1, are as follows:

Under ASC 840, many real estate lessors presented the revenue components for this type of lease agreement in two separate revenue line items in the income statement, usually titled “Rental Revenue” and “Tenant Reimbursement Revenue.”

Sample Presentation Under ASC 842 for Year Ended December 31, 20X1

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).

The following is a sample presentation if Lessor has elected the practical expedient under ASU 2018-11:

If Lessor has not elected 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” differs from previous practice under ASC 840 (as described above), we understand that many real estate lessors continue to provide 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

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.

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):