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When an arrangement contains both lease elements (lease of PP&E and the associated executory costs) and non-lease elements (services, disposables/consumables), the guidance under ASC 840 is applied to the lease elements by both the purchaser and the seller; however, it is not applied to any non-lease elements of the arrangement because such elements are outside the scope of ASC 840. "Substantial services" as contemplated by ASC 840-10-15-8 are not considered executory costs and, therefore, should not be considered lease deliverables. The total consideration in the arrangement should be allocated between the lease deliverables (e.g., lease of PP&E and executory costs) and the non-lease deliverables (e.g., services to operate the PP&E, cost of materials and supplies) on the basis of relative fair values in accordance with ASC 605-25 (revenue recognition of multiple element arrangements). The amount of payments to be allocated to minimum lease payments would be the consideration remaining after allocating payments to the non-lease deliverables, on the basis indicated in the previous sentence, and the executory cost items, on the basis of their aggregate fair value.
We believe there are several acceptable alternatives to allocating the arrangement consideration to the deliverables, labeled as follows:
  • Fixed Expected Volume Method
  • Variable Expected Volume Method
  • Minimum Volume Method
Below is an example for each of these alternatives based on the following facts:
Company M is a medical supply company providing hospitals with disposable supplies used in conjunction with specialized medical equipment. Company M enters into a 1 year arrangement with Hospital RX to provide free specialized medical equipment, in return for Hospital RX agreeing to purchase 500 disposables for $1 each. The fair value of the medical equipment lease and disposables is $100 and $1 each, respectively. Company M expects Hospital RX to purchase 1,000 disposables over the term of the agreement.
The free equipment meets the requirements as an embedded lease, and the disposables are accounted for in accordance with SAB Topic 13.A, Revenue Recognition.
Fixed Expected Volume Method
Under this method, relative fair value is calculated based on expected volumes. The value allocated to the lease deliverable is fixed. The allocated value is considered minimum lease payment.
The following depicts the relative fair value calculation:
Fair value of deliverables (expected purchase = 1,000 disposables) 1,000 + 100 = 1,100
Relative fair value of equipment lease [100 / 1,100] * 1,000 = 90
Relative fair value of disposables [1,000 / 1,100] * 1,000 = 910
$90 is allocated to the lease deliverable and will remain unchanged regardless of actual purchases. The rate at which fees received from the purchase of disposables is assigned to the ASC 840 deliverable is established assuming the customer will purchase only the minimum level of volumes. In this example, a deferral rate of 18 percent ($90/$500) is used to allocate fees from the consumables to the lease deliverable.
In this model, because the full amount allocated to the lease deliverable will eventually be recognized as rental income regardless of the actual volumes purchased, contingent rent is not consider to exist. Therefore, the full allocated value is treated as the minimum lease payment.
Note that, in situations where the amount allocated to the lease deliverable is greater than the minimum payments required under the arrangement, we believe it would be appropriate to use the smaller of those two amounts as the minimum lease payment.
Variable Expected Volume Method
Under this method, relative fair value is calculated based on expected volumes. The value allocated to the lease deliverable is variable. The minimum lease payment is calculated as a percentage of the minimum purchase requirement.
The following depicts the relative fair value calculation:
Fair value of deliverables (expected purchase = 1,000 disposables) 1,000 + 100 = 1,100
Relative fair value of equipment lease [100 / 1,100] * 1,000 = 90
Relative fair value of disposables [1,000 / 1,100] * 1,000 = 910
To calculate the minimum lease payment, the relationship between the lease deliverable to total deliverable value is multiplied by the minimum guaranteed purchase value (9% × $500 = $45). Nine percent of every sale (for the first 500 disposables sold) would be recorded as deferred rental income. Rent would be recognized by amortizing the MLP ($45 in this example) straight-line over the term of the agreement. For every sale beyond the contractual minimum volumes, revenue would be allocated between the lease deliverable and the non-lease deliverables using the 91%/9% split. Companies can elect to limit revenue allocated to the lease to the fair value of the lease or, alternately, companies could continue to recognize rental income throughout the duration of the contract (thereby possibly recognizing rental income in an amount in excess of the fair value of the lease).
Minimum Volume Method
Because the ultimate level of purchases is unknown, this model uses the contractual minimum volume in the relative fair value calculation. Under this model, relative fair value is calculated based on minimum purchase volumes. The value allocated to the lease deliverable is fixed. The allocated value is considered minimum lease payment.
The following depicts the relative fair value calculation
Fair value of deliverables 500 + 100 = 600
Relative fair value of equipment lease [100 / 600] * 500 = 85
Relative fair value of disposables [500 / 600] * 500 = 415
$85 is allocated to the lease deliverable, and will remain unchanged regardless of actual purchases.
In this model, because the full amount allocated to the lease deliverable will eventually be recognized as rental income, regardless of the actual volumes purchased, contingent rent is not consider to exist. Therefore, the full allocated value is treated as the minimum lease payment.
Note that other models could be used, and would be considered acceptable, as long as the model captures the economics of the transaction and honors the minimum lease payment provisions of ASC 840.
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