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Lessees classify leases as either operating or capital leases.

14.3.1A General disclosure requirements (ASC 840)

Lessees classify leases as either operating or capital leases.
As discussed in ASC 840-10-50-2, regardless of the type of lease, all lessees should disclose a general description of their leasing arrangements, including a description of leasing transactions with related parties. (Related party disclosures are discussed in FSP 26.)
The disclosures should include the significant terms of leasing arrangements, such as the following, if applicable:
  • Renewal or purchase options
  • Escalation clauses
  • Significant penalties and guarantees, such as residual value guarantees
  • Basis for determining contingent rental payments
  • Restrictions imposed by the agreements, such as against paying dividends

14.3.2A Operating leases (ASC 840)

In an operating lease, the lessee uses an asset for a period of time but does not obtain substantially all of the benefits or assume substantially all of the risks of owning the asset.

14.3.2.1A Presentation (ASC 840)

In an operating lease, the lessee does not record a lease obligation or an asset for the right to use the asset on its balance sheet. However, since payments under a lease can vary over its term, the lessee in an operating lease may be required to recognize certain lease-related assets or liabilities. Examples of these items include prepaid or accrued rent, capitalized initial direct costs, and lease incentives received. In a classified balance sheet, the lessee in an operating lease should present these assets and liabilities as current or noncurrent with other prepaid or accrued expenses with similar maturities.
ASC 840-20-45-1 indicates that the lessee in an operating lease should include rental costs in income from continuing operations (as opposed to combining it with interest expense). Reporting entities typically include rent expense with other expenses based on function, such as cost of goods sold or selling, general, and administrative expenses.

14.3.2.2A Disclosure (ASC 840)

Disclosures required for an operating lease focus primarily on the income statement and the commitments to make future payments under the lease. Example 1 of ASC 840-10-55-40 includes an illustration of a lessee’s application of the disclosure requirements for an operating lease.
Scope of disclosures
Inception of an operating lease is the date the terms are agreed to by the parties. Lease commencement is the date the lessee controls the use of the property.
The specific disclosure requirements of ASC 840 apply upon lease commencement. Prior to this date, the lessee should disclose its lease commitment in a manner similar to how it discloses commitments to purchase or construct properties that it will own in accordance with ASC 450, Commitments. See FSP 23 for discussion of commitments and contingencies.
Rental expense
As discussed in ASC 840-20-50-1, a lessee in an operating lease is required to disclose rental expense for each period for which an income statement is presented, with separate disclosure for minimum rentals, contingent rentals, and sublease rentals.
This disclosure may exclude rental payments under leases with terms of a month or less that were not renewed. For example, assume a construction company rents heavy equipment on a day-to-day basis in an arrangement that may be cancelled by either party at any time. The lessee may exclude those rents from its disclosure of rental expense even if those expenses are significant.
Minimum lease payments
As discussed in ASC 840-20-50-2(a), for operating leases that have initial or remaining noncancelable lease terms that are greater than one year, lessees should disclose the minimum rental payments for each of the next five years, and a sum for all years thereafter, followed by a total.
When preparing the disclosure of future minimum rental payments, a question may arise as to whether the lessee's disclosure should be based on (1) the future cash payments it is obligated to make, or (2) the expense it will recognize in the income statement on a straight-line basis. These amounts often differ, since many leases include non-level rents. While both approaches are acceptable, we believe the requirement was intended to reflect future cash payments. As a best practice, a lessee should clarify that the disclosure is based on contractually-required cash payments while expense recognition is on a straight-line basis.
The lessee may exclude lease payments that the lessee can avoid at its option. For example, the lessee may exclude rents due in a future extension period even if it is considered part of the lease term. If the lessee elects to exclude those rents, it should consider disclosing that fact. This election is only available to lessees that base their disclosure on future cash payments.
For foreign currency transactions, lessees should translate the amount of future minimum rental payments for purposes of the disclosure at the current exchange rate at the balance sheet date.
As discussed in ASC 840-20-50-2(b), a lessee should also disclose the total minimum rentals it is entitled to receive under noncancelable subleases, if any, as of the date of the latest balance sheet presented.
Exit obligations
When a lessee stops using a leased asset altogether during the lease term, the transaction may be subject to the accounting and disclosure requirements of ASC 420, Exit or Disposal Cost Obligations. See FSP 11 for discussion of disclosures related to restructuring activities.

14.3.3A Capital leases (ASC 840)

A lessee in a capital lease has obtained substantially all the benefits or assumed substantially all the risks of ownership of the asset. A capital lease is similar to the financed purchase of an asset.

14.3.3.1A Presentation (ASC 840)

As discussed in ASC 840-30-45-1, lessees should separately identify the gross amount of assets recorded under capital leases for each period a balance sheet is presented. This can be presented either on the balance sheet or in the footnotes.
As discussed in ASC 840-30-45-2, for capital leases, a lessee should also separately identify, on the balance sheet or in the footnotes, its obligations under capital leases. In a classified balance sheet, a lessee should present the current and noncurrent portions of its capital lease obligations in accordance with its operating cycle.
Since a capital lease is similar to other financed purchases of assets, interest expense is usually presented with other interest in the income statement as discussed in ASC 840-30-45-3. A lessee should either present the amortization of assets under a capital lease separately in the income statement, or disclose the amount in the footnotes.

14.3.3.2A Disclosure (ASC 840)

Example 1 of ASC 840-10-55-40 includes an illustration of lessee disclosures under capital leases.
Scope of disclosure
As with operating leases, prior to the commencement date, leases are not subject to the specific disclosure requirements of ASC 840, but a reporting entity instead should disclose its lease commitment similar to a commitment to purchase or construct properties that it will own. See FSP 23 for discussion of commitments and contingencies.
Classes of capital lease assets
Regardless of whether the capital lease information is presented on the balance sheet or in the footnotes, lessees should present assets recorded under capital leases by major class according to their nature or function (e.g., manufacturing facilities, retail facilities, or transportation equipment), along with the associated accumulated amortization. A lessee may combine this information with other comparable disclosures for owned assets.
Minimum lease payments
In accordance with ASC 840-30-50-1(b), a lessee should disclose the future minimum lease payments for each of the next five years, and a sum for all years thereafter, followed by a total. A lessee should subtract amounts representing executory costs included in the rent payment (e.g., maintenance, property taxes and property insurance) from this total to disclose the net minimum lease payments. Further, a lessee should subtract any imputed interest to disclose the present value of net minimum lease payments.
For capital leases, a lessee should also disclose the total minimum rentals it is entitled to receive under noncancelable subleases, if any, as of the date of the latest balance sheet presented, as discussed in ASC 840-30-50(c).
Contingent rentals
For capital leases, ASC 840-30-50(d), requires a lessee to disclose contingent rental expense for each period for which an income statement is presented, and disclose where the contingent rent was presented in the income statement.
Interest expense
As discussed in ASC 840-30-45-3, a lessee in a capital lease often presents interest expense with other interest in the income statement.
Amortization
ASC 840-30-45-3 allows a lessee in a capital lease to either present the amortization of assets under capital lease separately or disclose the amount in the footnotes.

14.3.4A Sale-leaseback transactions (ASC 840)

Sale-leaseback transactions involve the sale of property the seller will continue to use after it has transferred legal ownership of the asset to the buyer. A sale-leaseback transaction is one in which the seller recognizes both a sale and a separate leaseback of the asset sold.
As discussed in ASC 840-40-25-2, lessees classify the leaseback of the asset as either an operating or a capital lease. As such, lessees in sale-leaseback transactions apply the presentation and disclosure guidance applicable to the classification of the leaseback, either for an operating or capital lease, addressed in FSP 14.3.2A and FSP 14.3.3A, respectively.

14.3.4.1A Presentation (ASC 840)

A sale-leaseback transaction typically results in the seller-lessee deferring gains (or losses eligible for deferral). According to ASC 840-40-25-3, the presentation of the deferred gain (or loss) on the balance sheet depends on whether the lessee classifies the leaseback as a capital lease or as an operating lease.
When the leaseback is classified as a capital lease, the lessee would normally offset the deferred gain (or loss) against (or add it to) the asset.
When the leaseback is classified as an operating lease, the lessee may present the current and noncurrent portions of the deferred gain (or loss) within current or noncurrent liabilities (or assets), as appropriate.

14.3.4.2A Presentation of “failed” sale-leasebacks (ASC 840)

Because of the strict accounting guidance applicable to the sale and leaseback of real estate (including integral equipment), these transactions frequently do not qualify for sales recognition. In these “failed” sale-leaseback transactions, the seller-lessee continues to reflect the asset it “sold” on its balance sheet as if it still legally owns the asset. The lessee would typically reflect the sale proceeds received from the buyer-lessor as a financing on its balance sheet, even though the lease might otherwise have been classified as an operating lease had the transaction qualified for sale treatment.

14.3.4.3A Disclosure of “failed” sale-leasebacks (ASC 840)

In a failed sale-leaseback transaction, the seller-lessee should provide disclosures similar to any other financing obligation (see FSP 11 for discussion of disclosures related to various liabilities). Additionally, as discussed in ASC 840-40-50-1, the seller-lessee should describe the terms of the transaction, including future commitments and obligations that arise from the transaction and the circumstances that result in the seller-lessee’s continuing involvement with the “sold” asset. For example, if a seller-lessee did not account for a sale leaseback transaction as a sale because it has an option to repurchase the asset at its fair value at a future date, the lessee should disclose that provision as a form of continuing involvement with the asset.
In addition to the disclosures applicable for financing obligations discussed in FSP 12.12, under ASC 840-40-50-2, the seller-lessee in a failed sale-leaseback should continue to disclose the five-year data described in FSP 14.3.2.2A for operating leases. That is, the lessee should disclose the lease payments and any lease receipts on non-cancelable subleases associated with the failed sale-leaseback for each of the next five years and all periods thereafter, with a total.
The amounts in the financing and leasing disclosures will differ from how the lessee accounts for these cash payments. In a failed sale-leaseback transaction accounted for as a financing, for example, the lessee will recognize its cash payments as interest and principal payments, whereas the leasing disclosures focus on the gross cash flows.

14.3.5A Subleases (ASC 840)

Often, when a lessee subleases a leased property to a third party, the original lessee is not relieved of its primary obligation under the lease. In such transactions, the assets and liabilities related to the original lease should not be offset against assets and liabilities related to the sublease, unless the transactions qualify for right of offset under ASC 210-20. See FSP 14.3.2.2A and FSP 14.3.3.2A for disclosure requirements for subleases of operating leases and capital leases, respectively.
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