2.14 Leases
The focus of the SEC staff’s comments on leasing transactions has shifted from
registrants’ accounting under the legacy leasing guidance (codified in ASC 840) to
their application of the current leasing standard (codified in ASC 842). The next
sections discuss comment letter trends and other observations related to the
application of ASC 842.
2.14.1 Application of ASC 842
In addition to introducing a more principles-based accounting model, ASC 842
contains many quantitative and qualitative disclosure requirements, which
significantly increase the amount of information disclosed about leasing
activities and related transactions. Although relatively few SEC staff comments
on the application of ASC 842 have been issued thus far, some observations in
comments related to its application have emerged. For example, registrants have
received comments on (1) how ASC 842 applies or does not apply in certain
arrangements, and (2) the discount rate used to calculate the amount of the
lease liability and corresponding right-of-use (ROU) asset. Other topics
addressed in SEC staff comments on ASC 842 include, but are not limited to, the
nature of expenses treated as initial direct costs; the determination of lease
classification; accounting for leasehold improvements, including amortization ;
and impairment considerations related to ROU assets.
Given the relatively low volume of SEC staff comments related to ASC 842 that
have been issued thus far, registrants should continue monitoring staff comments
to identify any new comments or trends related to the leasing standard that may
emerge in the future.
2.14.1.1 Accounting for Arrangements Under ASC 842
Examples of SEC Comments
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We note that . . . you entered into a non-cancellable lease for an office building with an estimated construction cost of $[X] million. Please explain to us how you account for this project and lease agreement under ASC 842. See guidance in ASC 842-40-55-3 through 55-5.
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You indicate . . . that your [power purchase agreement (PPA)] arrangements are not accounted for as leases under ASC 842 since you have substantive substitution rights. Please tell us in further detail how you determined your PPAs met the conditions of ASC 842-10-15-10. In particular, given the nature of the assets, clarify how you benefit economically from the exercise of substitution rights. Additionally, describe to us the substitution provisions in your PPA contracts as well as your sale/leaseback contracts.
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We note your disclosure . . . that you are expecting to capitalize approximately $[X] million in total undiscounted lease payments related to . . . operating lease agreements that are in various stages of construction by the landlord. In order to better understand the Company’s accounting, please confirm whether the $[X] million is related to the amount expected to comprise the ROU asset at lease commencement. Furthermore, please tell us how the Company considered the guidance in ASC 842-40-55-3 through ASC 842-40-55-5 and the examples in ASC 842-40-55-40 through ASC 842-40-55-44 in accounting for such leases. In providing your answer please clarify whether the Company is incurring any costs prior to lease commencement and how the Company is accounting for such costs.
The SEC staff has asked registrants to explain how they determined whether
certain arrangements should be accounted for under ASC 842 and, if so, how
the guidance was applied to those arrangements. As required by ASC
842-20-50-1, a lessee should ensure that it has appropriately disclosed
qualitative information about its leases, including significant judgments
used in the application of ASC 842. The information that a lessee discloses
about the nature of its leases should be consistent with the disclosure
objective of ASC 842 and generally is qualitative (e.g., the extent to which
terms or conditions exist and a description of those terms or conditions).
Registrants should ensure that their disclosures sufficiently describe how
arrangements are accounted for in accordance with ASC 842, particularly when
individual transactions are significant.
Further, as noted in ASC 842-20-50-2, a lessee should consider the appropriate level of disclosure aggregation or disaggregation so that it avoids “including a large amount of insignificant detail or . . . aggregating items that have different characteristics.”
2.14.1.2 Discount Rate
Example of an SEC Comment
We note from your disclosure . . . that the weighted-average discount rate used
for finance leases is [X]% and the weighted-average
discount rate used for operating leases is [Y]%.
Please provide us with additional details regarding
how you determined or calculated the
weighted-average discount rates for each class of
your leases.
The SEC staff has asked registrants to explain and revise their disclosure about
the determination of the discount rate used to measure the lease liability
and ROU assets recorded in accordance with ASC 842. Specifically, ASC
842-20-50-3(c)(3) states that the information a lessee is required to
disclose about significant assumptions and judgments it made in applying the
requirements of ASC 842 may include the “determination of the discount rate
for the lease (as described in paragraphs 842-20-30-2 through 30-4).”
It is important for a lessee to consider disclosing information about the significant assumptions and judgments it used to determine its discount rate(s). For example, a lessee may need to disclose information regarding its determination of the incremental borrowing rate, such as collateral assumptions, the term used, and the economic environment in which the lease is denominated. To the extent that a portfolio approach is used to determine discount rates, a lessee should consider disclosing information about the composition of the portfolios.
In addition, since ASC 842-20-50-4(g)(4) requires lessees to disclose the
weighted-average discount rate for both operating and finance leases, a
lessee should consider whether the discount rate it used for some of its
leases is significantly different from the discount rate it used for other
leases and is therefore affecting the weighted-average calculation
disclosed. In these situations, a lessee may want to consider providing
additional disclosure of the discount rates that are affecting the lessee’s
disclosed weighted-average rate. Further, a lessee with multiple asset
classes of leases should consider providing additional disclosures on how
the weighted-average discount rate was determined for each asset class,
including any significant assumptions or judgments used in that calculation.
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