A Closer Look - FMSinc.org

A Closer Look

Discussion and Analysis of Current Accounting and Audit Issues

AC C O U N T I N G R E S E A RC H M A N AG E R ®

ISSUE 2016-2 • MARCH 1, 2016

Accounting and Financial Reporting of Leases Introduction

Background

On February 25, 2016, the Financial Accounting Standards Board (FASB) issued its new lease accounting guidance in Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842). This edition of “A Closer Look” examines the accounting and financial reporting for leases as amended by ASU 2016-02. Current U.S. GAAP requires lessees and lessors to classify leases as either capital leases or operating leases. Lessees recognize assets and liabilities for capital leases but do not recognize assets and liabilities for operating leases. A lessor classifies a lease as: (a) a sales-type lease; (b) a direct financing lease; or (c) a leveraged lease, when certain lease classification criteria are met. Otherwise, the lease is classified as an operating lease. ASU 2016-02 requires lessees to recognize assets and liabilities for all leases (with an exception for short-term leases). Lessor accounting is substantially unchanged. Lessor accounting is similar to existing sales-type and direct financing accounting. ASU 2016-02, however, eliminates leveraged lease accounting. A lessor would account for leases that currently qualify as leveraged leases consistent with all other leases. Leveraged leases existing before the effective date of ASU 2016-02 should apply the requirements of Subtopic 842-50.

The accounting for leases was identified as a joint project in the 2006 memorandum of understanding between the FASB and the International Accounting Standards Board (IASB) (collectively, the Boards). The leases project was added to the joint agenda in response to concerns from investors and other financial statement users, including the Securities and Exchange Commission (SEC), about the lack of transparency relating to material lease obligations that are reported off-balance sheet. Following the Enron bankruptcy, the SEC staff identified leasing as a form of off-balance sheet accounting that needed to be addressed. In March 2009, the Boards issued a discussion paper, Leases: Preliminary Views. The discussion paper presented the Board’s preliminary views on lessee accounting for leases and proposed a right-of-use accounting model. In August 2010, after considering responses to the discussion paper, the Boards published joint proposals to change the accounting and financial reporting for lease contracts. The Boards received substantial feedback on the proposals. In May 2013, after considering responses to the August 2010 proposal, the Boards published revised joint proposals on the accounting and financial reporting for lease contracts. The Boards

Visit Accounting Research Manager on the web at www.accountingresearchmanager.com

© 2016 CCH Incorporated and its affiliates. All rights reserved.

A Closer Look — Discussion and Analysis of Current Accounting and Audit Issues

again received substantial feedback on the proposals. When considering responses to the May 2013 proposals, the Boards reached different conclusions on certain aspects of the proposals. As a result, lease accounting was not converged although the Boards reached the same conclusions in many areas of lease accounting. On January 13, 2016, the IASB issued International Financial Reporting Standard (IFRS) 16, Leases, which replaces IAS 17, Leases, and related interpretations. IFRS 16 is effective for annual reporting periods beginning on or after January 1, 2019. IFRS 16 may be applied earlier if IFRS 15, Revenue from Contracts with Customers, is applied before or as IFRS 16 is applied. The issuance of ASU 2016-02 and IFRS 16 is the completion of the process to revise the accounting for leases.

Scope Current U.S. GAAP specifies that only property, plant, or equipment (which includes only land and depreciable assets) can be the subject of a lease. ASU 2016-02 also specifies that only property, plant, or equipment (which includes only land and depreciable assets) can be the subject of a lease. The new guidance specifically states that leases of right-of-use assets in a sublease are in scope. The following, however, are excluded from the scope of the leasing guidance: • Leases of intangible assets; • Leases to explore for or use minerals, oil, natural gas, and similar non-regenerative resources; • Leases of biological assets, including timber; • Leases of inventory; and • Leases of assets under construction. Service concession arrangements within the scope of Topic 853 Service Concession Arrangements are not within the scope of the new lease guidance.

Application to Nonpublic Entities

There are no alternative recognition, measurement, disclosure, presentation, or transition provisions for nonpublic business entities. Nonpublic business entities would apply the new lease guidance like public business entities with one exception. The new lease guidance allows nonpublic entities, as an accounting policy election for all leases, to use a risk-free discount rate for the measurement of lease liabilities. Application to Related Parties

Lessees and lessors that are related parties should apply the recognition and measurement requirements for leases on the basis of the legally enforceable terms and conditions of the lease. Lessees and lessors should also apply the related party disclosure requirements in Topic 850 Related Party Disclosures. Subleases

A sublease is defined 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 lessee remains in effect.” An intermediate lessor (i.e., an entity that is both a lessee and a lessor of the same underlying asset) should account for a head lease and a sublease as two separate contracts. The head lease is accounted for in accordance with the lessee guidance and the sublease in accordance with the lessor guidance. Portfolio Application

ASU 2016-02 specifies the accounting for an individual lease. However, as stated in the basis for conclusions, the new leases guidance may be applied to a portfolio of leases with similar characteristics if there is a reasonable expectation

Visit Accounting Research Manager on the web at www.accountingresearchmanager.com © 2016 CCH Incorporated and its affiliates. All rights reserved.

2

March 1, 2016


that the effects on the financial statements of applying the lease guidance to the portfolio would not differ materially from applying the guidance to the individual leases within that portfolio. If accounting for a portfolio, estimates and assumptions should be used that reflect the size and composition of the portfolio. Combination of Contracts

Two or more contracts entered into at or near the same time with the same counterparty (or related parties of the counterparty) should be combined and accounted for as a single contract if one or more of the following criteria are met: • The contracts are negotiated as a package with an overall commercial objective; • The amount of consideration to be paid in one contract depends on the price or performance of the other contract; or • The rights to use underlying assets conveyed in the contracts (or some rights to use underlying assets conveyed in each of the contracts) form a single lease component.

Definition of a Lease ASU 2016-02 defines a lease as “a contract, or part of a contract, that conveys the right to control the use of identified property, plant and equipment (an identified asset) for a period of time in exchange for consideration.” The critical determination is whether a contract is or contains a lease because lessees are required to recognize lease assets and lease liabilities for all leases, both finance and operating, other than short-term leases. This definition is different from the legacy definition of a lease, which is “an agreement conveying the right to use property, plant, or equipment (land and/or depreciable assets) usually for a stated period of time.” The critical determination in this definition was whether

a lease was a capital lease or an operating lease because lease assets and lease liabilities were recognized only for capital leases.

Identifying a Lease A key step in the accounting for leases is to determine whether a contract contains a lease. The assessment should be made for each potential separate lease component. A contract is defined as an “agreement between two or more parties that creates enforceable rights and obligations.” The assessment of whether a contract is, or contains, a lease is performed at the inception of a contract. A contract is, or contains, a lease if the contract conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. A period of time may be described in terms of the amount of use of an identified asset (e.g., the number of production units that an item of equipment will be used to produce). If the customer has the right to control the use of an identified asset for only a portion of the term of the contract, the contract contains a lease for that portion of the term. Reassessment

A reassessment of whether a contract is, or contains, a lease is performed only if the terms and conditions of the contract are changed. Assessment of Whether a Contract Contains a Lease

Following is a summary of the assessment of whether a contract contains a lease in a question and answer format. A contract that does not contain a lease is accounted for according to other applicable guidance.


3

March 1, 2016


Is there an identified asset?

• If there is no identified asset, the contract does not contain a lease. If there is an identified asset, does the customer have the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use? • If customer does not have this right, the contract does not contain a lease. If the customer has the right to obtain substantially all of the economic benefits from use of the asset throughout the period of use, does the customer or the supplier have the right to direct how and for what purpose the asset is used throughout the period of use? • If the supplier has this right, the contract does not contain a lease. • If the customer has this right, the contact contains a lease. If neither the supplier nor the customer has this right (the how and for what purpose the asset will be used is predetermined), does the customer have the right to operate the asset throughout the period of use without the supplier having the right to change those operating instructions? • If the customer has this right, the contract contains a lease. If the customer does not have this right, did the customer design the asset (or specific aspects of the asset) in a way that predetermines how and for what purpose the asset will be used throughout the period of use? • If the customer did not design the asset, the contract does not contain a lease.

• If the customer designed the asset, the contract contains a lease.

Separating Components of a Contract Contracts may contain lease and nonlease (service) components, or multiple lease components. Separate lease components within the contract, if any, should be identified and accounted for separately. The right to use an underlying asset should be considered a separate lease component if both of the following criteria are met: • The lessee can benefit from the right of use of the asset either on its own or together with other resources that are readily available to the lessee (goods or services that are sold or leased separately or resources that the lessee has already obtained). • The right of use is neither highly dependent on nor highly interrelated with the other right or rights of use in the contract. In a lease of land and other assets, the right to use land should be accounted for as a separate lease component unless the effect of such accounting is insignificant. Contract consideration should be allocated to each separate lease component that has been identified. Activities (or costs of the lessor) that do not transfer a good or service to the lessee are not components in a contract. Lessee

A lessee should separate lease components from non-lease components unless the lessee applies an accounting policy election, by class of underlying asset, to not separate lease components from non-lease components. In applying the accounting policy election, a lessee would account for lease and nonlease components together as a single lease component.


4

March 1, 2016


A lessee should allocate the consideration in the contract to the lease and non-lease components on a relative standalone price basis using observable standalone prices. A lessee also should reallocate the consideration in a contract when: (a) there is a reassessment of either the lease term or a remeasurement of the lease liability; or (b) there is a contract modification that is not accounted for as a separate, new contract. Lessor

A lessor would allocate the consideration in the contract using the requirements for allocating the transaction price to separate performance obligations in Topic 606 Revenue from Contracts with Customers. A lessor also should reallocate the consideration in a contract when there is a contract modification that is not accounted for as a separate, new contract using the requirements in Topic 606.

Lease Term The lease term is the noncancellable period of the lease, together with; (a) periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option; (b) periods covered by an option to terminate the lease if the lessee is reasonably not certain to exercise that option and (c) periods covered by an option to extend (or not to terminate) the lease in which exercise of the option is controlled by the lessor. The lease term begins at the commencement date (i.e., the date on which a lessor makes an underlying asset available for use by a lessee) and includes any rent-free periods provided to the lessee by the lessor. When assessing the noncancellable period of a lease, the period for which the contract is enforceable should be determined. A lease is not enforceable when both the lessee and the

lessor each have the right to terminate the lease without permission from the other party with no more than an insignificant penalty. If only a lessee has the right to terminate a lease, that right is considered to be an option to terminate the lease. If only a lessor has the right to terminate a lease, the noncancellable period of the lease includes the period covered by the option to terminate the lease. A lessee should reassess the lease term or a lessee option to purchase the underlying asset only if and at the point in time that any of the following occurs: • There is a significant event or a significant change in circumstances that is within the control of the lessee that directly affects whether the lessee is reasonably certain to exercise or not to exercise an option to extend or terminate the lease or to purchase the underlying asset. • There is an event that is written into the contract that obliges the lessee to exercise (or not to exercise) an option to extend or terminate the lease. • The lessee elects to exercise an option even though the entity had previously determined that the lessee was not reasonably certain to do so. • The lessee elects not to exercise an option even though the entity had previously determined that the lessee was reasonably certain to do so. A lessor is not required to reassess the lease term or a lessee option to purchase the underlying asset unless the lease is modified and that modification is not accounted for as a separate contract. When a lessee exercises an option to extend or terminate the lease or purchase the underlying asset, the lessor should account for the exercise of that option in the same manner as a lease modification.


5

March 1, 2016


Classification of Leases At the commencement date, a lessee would classify a lease as either: • A finance lease; or • An operating lease. At the commencement date, a lessor would classify a lease as either: • A sales-type lease; • A direct financing lease; or • An operating lease. Lessees

A lessee would classify a lease as a finance lease when the lease meets any of the following criteria: • The lease transfers ownership of the underlying asset to the lessee by the end of the lease term. • The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise. • The lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset (the last 25% of the economic life), this criterion should not be used. • The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all (90% or more) of the fair value of the underlying asset. • The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

When none of these criteria are met a lessee would classify the lease as an operating lease. The lease classification is reassessed only when: (a) the contract is modified and the modification is not accounted for as a separate contract; and (b) there is a change in the lease term or the assessment of whether the lessee is reasonably certain to exercise an option to purchase the underlying asset. Lessors

A lessor would classify a lease as a sales-type lease when the lease meets any of the following criteria: • The lease transfers ownership of the underlying asset to the lessee by the end of the lease term. • The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise. • The lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset (the last 25% of the economic life), this criterion should not be used. • The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all (90% or more) of the fair value of the underlying asset. • The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term. When none of these criteria are met a lessor would classify the lease as a direct financing lease when both of the following criteria are met:


6

March 1, 2016


• The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments and/or any other third party unrelated to the lessor equals or exceeds substantially all (90% or more) of the fair value of the underlying asset. • It is probable that the lessor will collect the lease payments plus any amount necessary to satisfy a residual value guarantee. When none of these criteria are met a lessor would classify the lease as an operating lease. The lease classification is reassessed only when the contract is modified and the modification is not accounted for as a separate contract.

Contract Modifications Contractual terms and conditions of a lease may be modified so that there is a substantive change to the existing lease. A modification to a contract is accounted for as a separate contract (i.e., separate from the original contract) when both of the following conditions are present: • The modification grants the lessee an additional right of use not included in the original lease (e.g., the right to use an additional asset). • The lease payments increase commensurate with the standalone price for the additional right of use, adjusted for the circumstances of the particular contract. If a lease is modified and that modification is not accounted for as a separate contract, the classification of the lease should be reassessed as of the effective date of the modification based on its modified terms and conditions and the facts and circumstances as of that date.

Initial Direct Costs Initial direct costs are “incremental costs of a lease that would not have been incurred if the lease had not been obtained.” The same definition of initial direct costs applies to lessees and lessors.

Lessee Accounting ASU 2016-02 requires lessees to recognize the following for all leases (except for those leases classified as short-term leases) at the commencement date: • A lease liability, which is a lessee‘s obligation to make lease payments arising from a lease, measured on a discounted basis; and • A right-of-use asset, which is an asset that represents the lessee’s right to use an underlying asset for the lease term. Short-Term Leases

Lessees may elect, as an accounting policy, to apply simplified accounting similar to current operating lease accounting to short-term leases. The election would be made by class of underlying asset to which the lease relates. A lessee would recognize lease payments as an expense on a straight-line basis over the lease term. Variable lease payments would be recognized in the period in which the obligation is incurred. A short-term lease is a “lease that, at the commencement date, has a lease term of 12 months or less and does not contain an option to purchase the underlying asset that the lessee is reasonably certain to exercise.”


7

March 1, 2016


Lease Liability

The lease liability is initially measured at the present value of the lease payments discounted using the rate implicit in the lease. If that rate is not available, the lessee would use its incremental borrowing rate. Nonpublic entities are permitted, as an accounting policy election for all leases, to use a risk-free discount rate, determined using a period comparable to that of the lease term. The rate implicit in the lease is the rate of interest that causes the sum of the present value of: (a) the lease payments; and (b) the amount that a lessor expects to derive from the underlying asset at the end of the lease term, to equal the sum of: (a) the fair value of the underlying asset less any related investment tax credit retained by the lessor; and (b) any initial direct costs of the lessor. Lease payments included in the initial measurement of the lease liability consist of the following that are not yet paid: • Fixed payments, less any lease incentives receivable from the lessor; • In-substance fixed payments (payments that may, in form, contain variability but that, in-substance, are unavoidable); • Variable lease payments that depend on an index or a rate (e.g., the Consumer Price Index or a market interest rate), initially measured using the index or rate at the commencement date; • Amounts expected to be payable by the lessee under residual value guarantees; • The exercise price of a purchase option if the lessee is reasonable certain to exercise that option; • Fees paid to the owners of a special-purpose entity for structuring the transaction; and • Payments for penalties for terminating the lease if the lease term reflects the lessee exercising an option to terminate the lease.

A lessee subsequently measures the lease liability by: • Increasing the carrying amount to reflect interest on the lease liability; and • Reducing the carrying amount to reflect the lease payments made. Interest on the lease liability in each period during the lease term is the amount that produces a constant periodic interest rate on the remaining balance of the liability. Right-of-Use Asset

The right-of-use asset is initially measured at cost, which consists of all of the following: • The amount of the initial measurement of the lease liability; • Any lease payments made at or before the commencement date, less any lease incentives received; and • Any initial direct costs incurred by the lessee. Impairment

A lessee would determine whether the right-ofuse asset is impaired and would recognize any impairment loss in accordance with Topic 360, Property, Plant, and Equipment. Reassessment of the Lease Liability

After the commencement date, a lessee would remeasure the lease liability to reflect: (a) lease payment changes; and (b) changes to the discount rate. Presentation Finance Leases

After the commencement date, a lessee would generally recognize in profit or loss:


8

March 1, 2016


9

• Amortization of the right-of-use asset and interest on the lease liability; • Variable lease payments not included in the lease liability in the period in which the obligation for those payments is incurred; and • Any impairment of the right-of-use asset.

• Its leases; • The significant judgments made in accounting for its leases; and • Amounts recognized in the financial statements for its leases.

Operating Leases

ASU 2016-02 leaves lessor accounting substantially unchanged. The new lease guidance, however, eliminates leveraged lease accounting. ASU 2016-02 requires a lessor to account for a lease as a sales-type lease, a direct financing lease or an operating lease.

After the commencement date, a lessee would generally recognize all of the following in profit or loss: • A single lease cost, calculated so that the remaining cost of the lease is allocated over the remaining lease term generally on a straight-line basis. • Variable lease payments not included in the lease liability in the period in which the obligation for those payments is incurred. • Any impairment of the right-of-use asset. Accounting for the Purchase of a Leased Asset by the Lessee during the Lease Term

If a lessee purchases a leased asset during the lease term, any difference between the purchase price and the carrying amount of the lease liability should be recorded as an adjustment of the carrying amount of the asset. No gain or loss should be recognized. Lessee Disclosure

ASU 2016-02 establishes a disclosure objective for lessee disclosures and requires additional disclosures. The objective of the required disclosures is to provide users of financial statements with information to understand the amount, timing, and uncertainty of cash flows arising from leases. A lessee should disclose qualitative and quantitative information about all of the following:

Lessor Accounting

Sales-Type Leases

At the commencement date, a lessor would recognize each of the following: • A net investment in the lease (the sum of the lease receivable and the unguaranteed residual asset); • Selling profit or selling loss arising from the lease; and • Initial direct costs as an expense if the fair value of the underlying asset is different from its carrying amount. A lease receivable is a lessor’s right to receive lease payments arising from a sales-type lease or a direct financing lease plus any amount that a lessor expects to derive from the underlying asset following the end of the lease term to the extent that it is guaranteed by the lessee or any other third party unrelated to the lessor, measured on a discounted basis. An unguaranteed residual asset is the amount that a lessor expects to derive from the underlying asset following the end of the lease term that is not guaranteed by the lessee or any other third party unrelated to the lessor, measured on a discounted basis.


March 1, 2016


10

Lease payments receivable consist of the following payments during the lease term that are not yet received:

A lessor would initially measure the net investment in the lease to include both of the following:

• Fixed payments, less any lease incentives payable; • In-substance fixed payments (payments that may, in form, contain variability but that, in-substance, are unavoidable); • Variable lease payments that depend on an index or a rate (e.g., the Consumer Price Index or a market interest rate), initially measured using the index or rate at the commencement date; • Residual value guarantees; • The exercise price of a purchase option if the lessee is reasonably certain to exercise that option; • Payments for penalties for terminating the lease if the lease term reflects the lessee exercising an option to terminate the lease; and • Fees paid by the lessee to the owners of a special purpose entity for structuring the transaction.

• The lease receivable, which is measured at the present value, discounted using the rate implicit in the lease, of: (a) the lease payments not yet received by the lessor; and (b) the amount the lessor expects to derive from the underlying asset following the end of the lease term that is guaranteed by the lessee or any other third party unrelated to the lessor; and • The unguaranteed residual asset at the present value of the amount the lessor expects to derive from the underlying asset following the end of the lease term that is not guaranteed by the lessee or any other third party unrelated to the lessor, discounted using the rate implicit in the lease.

The carrying amount of the underlying asset would be derecognized unless the collectibility of the lease payments is not probable. If collectibility is not probable, the lessor would recognize lease payments received a deposit liability. After the commencement date, a lessor would recognize all of the following: • Interest income on the net investment in the lease; • Variable lease payments that are not included in the net investment in the lease as income in profit or loss in the period when the changes in facts and circumstances on which the variable lease payments are based occur; and • Impairment of the net investment in the lease.

A lessor would subsequently measure the net investment in the lease by doing both of the following: • Increasing the carrying amount to reflect the interest income on the net investment in the lease. • Reducing the carrying amount to reflect the lease payments collected during the period. The interest income on the net investment in the lease is determined as the amount that produces a constant periodic discount rate on the remaining balance of the net investment in the lease. The net investment in the lease is not remeasured unless the lease is modified and that modification is not accounted for as a separate contract. The rate implicit in the lease is the rate of interest that causes the sum of the aggregate present value of: (a) the lease payments; and (b) the amount that a lessor expects to derive from


March 1, 2016


the underlying asset at the end of the lease term, to equal the sum of: (a) the fair value of the underlying asset less any related investment tax credit retained by the lessor; and (b) any initial direct costs of the lessor. A lessor should assess the net investment in the lease (i.e., both the lease receivable and any unguaranteed residual asset) for impairment in accordance with Topic 310, Receivables. Direct Financing Leases

At the commencement date, a lessor should recognize: (a) the net investment in the lease (the sum of the lease receivable and the unguaranteed residual asset, net of any deferred selling profit); and (b) any selling loss from the lease. The lessor should derecognize the underlying asset. Selling profit and initial direct costs are deferred at the commencement date and included in the measurement of the net investment in the lease. The rate implicit in the lease is defined in such a way that initial direct costs deferred are included automatically in the net investment in the lease; there is no need to add them separately. After the commencement date, a lessor should recognize all of the following: • Interest income on the net investment in the lease; • Variable lease payments that are not included in the net investment in the lease in the period when the changes in facts and circumstances on which the variable lease payments are based occur; and • Impairment of the net investment in the lease. The net investment in the lease is measured to include the following: • The lease receivable, which is measured at the present value, discounted using the rate implicit in the lease, of: (a) the lease payments

not yet received by the lessor; and (b) the amount the lessor expects to derive from the underlying asset following the end of the lease term that is guaranteed by the lessee or any other third party unrelated to the lessor; and • The present value of the unguaranteed residual asset. The sum of the above is by the amount of any selling profit. The net investment in the lease is subsequently measured by doing both of the following: • Increasing the carrying amount to reflect the interest income on the net investment in the lease; and • Reducing the carrying amount to reflect the lease payments collected during the period. Interest income on the net investment is determined as the amount that produces a constant periodic discount rate on the remaining balance of the net investment in the lease. The net investment in the lease is not remeasured unless the lease is modified and that modification is not accounted for as a separate contract. A lessor should assess the net investment in the lease (i.e., both the lease receivable and any unguaranteed residual asset) for impairment in accordance with Topic 310, Receivables. Operating Leases

For a lease classified as an operating lease, a lessor continues to recognize the underlying asset and recognizes lease income over the lease term. A lessor recognizes lease payments as lease income over the lease term generally on a straightline basis. Initial direct costs are recognized as an expense over the lease term on the same basis as lease income is recognized. Variable lease payments are recognized in income in the period in which that income is earned.


11

March 1, 2016


The underlying asset should be subsequently measured and presented in accordance with other relevant guidance. Cash receipts from lease payments should be presented within operating activities in the statement of cash flows. Lessor Disclosure

ASU 2016-02 establishes a disclosure objective for lessor disclosures and requires additional disclosures. The objective of the required disclosures is to provide users of financial statements with information to understand the amount, timing, and uncertainty of cash flows arising from leases. A lessor should disclose qualitative and quantitative information about all of the following: • Its leases; • The significant judgments made in accounting for its leases; and • Amounts recognized in the financial statements for its leases.

Sale and Leaseback Transactions ASU 2016-02 simplified the accounting for sale and leaseback transactions primarily because lessees must now recognize lease assets and lease liabilities. Lessees will no longer be provided with a source of off-balance sheet financing. In a sale and leaseback transaction, one entity (i.e., the seller-lessee) transfers an asset to another party (i.e., the buyer-lessor) and immediately leases back that same asset. If the transaction meets the criteria for a sale, both the seller-lessee and the buyer-lessor will account for the sale and the lease. If the transaction does not meet the criteria for a sale, the transaction is accounted for as a financing. The primary issue in accounting for sale and leaseback transactions is the determination of whether a contract exists and a transfer is a sale. Under the new guidance, the existence of

a contract and whether control of the asset is transferred to the buyer are determined following the requirements in Topic 606 Revenue from Contracts with Customers. The existence of the leaseback does not, in isolation, prevent the buyer-lessor from obtaining control of the asset. Transfer of the Asset Is a Sale

If a buyer-lessor obtains control of the asset: • The seller-lessee accounts for a sale in accordance with Topic 606, derecognizes the underlying asset, and accounts for the lease in accordance with lessee accounting guidance. • The buyer-lessor accounts for a purchase in accordance with other applicable guidance and for the lease in accordance with lessor accounting guidance. Fair Value Adjustments.

If the consideration for the sale of an asset: (a) is not at fair value; or (b) the lease payments are not at market rates, the seller-lessee and buyer-lessor should adjust the measurements to recognize the sale at fair value and subsequently account for the lease to reflect those current market rates. Related party leases, however, need not reflect such adjustments. Transfer of the Asset Is Not a Sale

If a buyer-lessor does not obtain control of the asset, the transfer is not a sale. In this case: • The transferor does not derecognize the transferred asset and accounts for any amounts received as a financial liability. • The transferee should not recognize the transferred asset and should account for the amounts paid as a receivable.


12

March 1, 2016


Effective Date The amendments in ASU 2016-02 are effective for public business entities for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years (i.e., January 1, 2019, for a calendar year entity). Nonpublic business entities should apply the amendments for fiscal years beginning after December 15, 2019 (i.e., January 1, 2020, for a calendar year entity), and interim periods within fiscal years beginning after December 15, 2020. Early application is permitted for all public business entities and all nonpublic business entities.

Transition Lessees

Lessees must apply a modified retrospective transition approach for capital and operating leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessees may not apply a full retrospective transition approach. With an effective date of January 1, 2019, for a calendar year public business entity, a lessee presenting three year comparative financial statements would apply the transition provisions as of January 1, 2017 (the earliest comparative period presented). Lessors

Lessors must apply a modified retrospective transition approach for sales-type, direct financing, and operating leases existing at, or entered

into after, the beginning of the earliest comparative period presented in the financial statements. The modified retrospective approach would not require any transition accounting for leases that expired before the earliest comparative period presented. Lessors may not apply a full retrospective transition approach. With an effective date of January 1, 2019, for a calendar year public business entity, a lessor presenting three year comparative financial statements would apply the transition provisions as of January 1, 2017 (the earliest comparative period presented). Practical Expedients

Lessees and lessors may elect the following specified reliefs. These reliefs must be elected as a package and must be applied to all of a lessee’s and lessor’s leases (i.e., they cannot be elected on a lease-by-lease or relief-by-relief basis). Lessees and lessors may elect not to reassess: • Whether any expired or existing contracts are or contain leases; • The lease classification for any expired or existing leases; and • Initial direct costs for any existing leases (i.e., whether those costs would have qualified for capitalization under the new leases guidance). Lessees and lessors may also elect to use hindsight in determining the lease term (i.e., lessee options to extend or terminate the lease or purchase the underlying asset) and in assessing impairment of the right-of-use asset. This specified relief may be elected separately or in conjunction with the above specified reliefs as an accounting policy election (i.e., it cannot be elected on a lease-by-lease basis).

To discover how Accounting Research Manager® can help you stay in compliance with recently issued standards and developments, contact your Wolters Kluwer Account Representative. “A Closer Look” was written by the Chicago-based staff of Wolters Kluwer’s Accounting Research Manager’s expert editorial team and is part of our extensive collection of unique thought leadership content. It is published with the understanding that the publisher is not engaged in rendering legal, accounting, tax, or other professional services. If legal, accounting, tax advice, or other professional assistance is required, the services of a competent professional should be sought.

13