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14.3 Lessors
Publication date: 31 Jan 2023
us Financial statement presentation guide
Lessors are required to classify leases as sales-type, direct financing, or operating leases.
14.3.1 Lessors: Balance sheet presentation
A lessor’s presentation of its leased asset is dependent on how the lease is classified.
14.3.1.1 Lessors: Sales-type and direct financing leases
In a sales-type or direct financing lease, the lessor derecognizes the leased asset and recognizes a lease investment on its balance sheet as discussed in LG 4.3.1. A lessor’s aggregate net investment should be presented separate from other assets on the lessor’s balance sheet.
Lease assets should be classified as current or noncurrent. See FSP 2 for information on balance sheet classification.
14.3.1.2 Lessors: Operating lease balance sheet presentation
A lessor should classify assets subject to operating leases as property, plant, and equipment (e.g., within buildings) or as a separate line item on the balance sheet (e.g., assets subject to operating leases). As with other fixed assets, property subject to operating leases may be presented net of accumulated depreciation on the balance sheet, but the accumulated depreciation should be shown on the face of the balance sheet or disclosed in the notes to the financial statements.
For operating leases with rents that change over time, the requirement to recognize rental income on a straight-line basis may generate a rent receivable or deferred rent revenue on the lessor's balance sheet. A lessor may also need to recognize a prepaid asset on the balance sheet arising from initial direct costs that the lessor will recognize as an expense over the lease term. Lessors should present a rent receivable, deferred rent, or prepaid initial direct costs with items of similar maturities on a classified balance sheet; for example, with other prepaid items associated with long-term contracts. See FSP 2 for information on balance sheet classification.
14.3.2 Lessors: Income statement presentation
LG 2 addresses certain concepts that impact the presentation in the income statement, including:
- Taxes (LG 2.4.1): ASC 842 permits lessors to gross up the income statement by presenting (1) sales or other similar taxes in revenue when such taxes are reimbursed by a lessee to the lessor and (2) the associated tax payment to the taxing authorities as expense. However, lessors can also make an accounting policy election to exclude from revenue and associated expense such taxes assessed by a governmental authority provided they are (a) imposed on and concurrent with a specific lease revenue-producing transaction, and (b) collected by the lessor from the lessee. This election is available irrespective of whether the taxes are a lessee or lessor cost. Examples of taxes eligible for this policy election include sales, use, value added, and some excise taxes. Taxes assessed on a lessor’s gross receipts or on the lessor as owner of the underlying asset are excluded. Lessors are required to disclose their accounting policy election.
- Other lessor costs paid directly by the lessee to a third party (LG 2.4.1): ASC 842 requires a lessor to present a variable payment not included in contract consideration that is even partially related to a lease component on a gross basis in its income statement, i.e., it needs to be separately reported as revenue and expense. ASU 2018-20 provides relief from such gross presentation and requires a lessor to present the expense and payment by a lessee on a net basis (i.e., zero effect on the lessor’s income statement) if the lessee directly remits the payment to a third party. However, this relief is not available if a lessor remits payment to a third party and is subsequently reimbursed by the lessee.
- Combining lease and certain nonlease components (LG 2.4.4.1): A lessor can elect a practical expedient, by class of underlying asset, to present lease and nonlease components together as one combined component if certain conditions are met. The combined component should be accounted for as a single performance obligation in accordance with ASC 606, Revenue from Contracts with Customers, if the nonlease component is the predominant component. Otherwise, the lessor should account for the combined component as a lease.
- Embedded leases (LG 2.3): Some leases embedded in service contracts may not have explicit consideration stated for the embedded lease. We believe arrangements that do not have stated consideration for embedded leases should generally be accounted for on a gross basis. Thus, a vendor should gross up its income statement for the "free" embedded lease. That is, the vendor should recognize additional revenue for the sale of its products/services to a customer and expense for the "free" embedded lease of the customer's asset.
The following subsections address how a lessor should present income in various situations.
14.3.2.1 Sales-type and direct financing leases
ASC 842-30-45-3 through ASC 842-30-45-4 provide guidance on a lessor's presentation of sales-type and direct financing leases in the income statement.
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.
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:
a. 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.
b. If a lessor uses leases for the purposes of providing finance, the lessor shall present the profit or loss in a single line item.
A lessor in a sales-type lease will recognize a selling profit or loss (as well as the initial direct costs) at lease commencement. A lessor in a direct financing lease should defer the selling profit and initial direct costs, both of which are included in the net investment of the lease.
A sales type or direct financing lease results in a day-one selling loss when the fair value of the leased asset is lower than its carrying value plus initial direct costs incurred in connection with signing the lease. A lessor in a sales-type or direct financing lease that has not yet adopted ASU 2021-05 will recognize a selling loss upfront at lease commencement. Following its adoption of ASU 2021-05, the accounting by a lessor for a selling loss depends on whether the lease has variable payments that do not depend on an index or a rate. If so, the lease is classified as an operating lease. If not, the lessor will recognize a selling loss at lease commencement.
Any profit or loss recognized for a sales-type lease should be presented in a manner that best reflects the business model associated with the leased asset. For example, a manufacturer that leases assets as a means of realizing value from goods it would otherwise sell may present the revenue and cost of goods sold on a gross basis. Alternatively, if a lessor leases assets to generate revenue by providing financing, it may be appropriate to present the net profit or loss in a single line item.
For a direct financing lease, amortization of the initial direct costs should be recorded as a reduction of interest income, rather than as an expense, in accordance with ASC 835-30-45-3. Likewise, a loss in a direct financing lease should be presented in the same manner (i.e., a single line item). See LG 4.3.1.1 for additional details.
Variable lease payments
ASC 842 does not explicitly address whether variable lease payments received for a direct financing lease or sales type lease should be presented as lease income or interest income. We believe that either presentation is appropriate but careful consideration should be given to the economics of the lease when making this determination. For example, if a lease with all variable payments is classified as a sales type lease, no lease receivable would be recorded; in this case, it would be difficult to support presentation of the variable payments as interest income given there is no receivable associated with the lease.
14.3.2.2 Lessors: Operating lease income statement presentation
A lessor should recognize all of the following:
- Lease payment as income in profit or loss over the lease term on a straight-line basis unless another systematic and rational basis is more representative of the pattern in which a benefit is expected to be derived from the use of the underlying asset
- Variable lease payments as income in profit or loss in the period in which changes in facts and circumstances on which the variable lease payments are based occur
- Initial direct cost as an expense over the lease term on the same basis as lease income
A lessor should continue to measure the underlying asset subject to an operating lease in accordance with other GAAP. Depreciation of the underlying asset should be presented gross and should not offset rental income.
14.3.2.3 Subleases
ASC 842 requires that an intermediate lessor (i.e., a sublessor) disclose sublease income on a gross basis, separate from the finance or operating lease expense. However, there is no explicit guidance that addresses income statement presentation of sublease income.
Question 14-1
Can a sublessor net sublease income against head lease expense in the income statement?
Can a sublessor net sublease income against head lease expense in the income statement?
PwC response
It depends.
We believe gross presentation on the income statement is acceptable in all cases. Under gross presentation, the sublessor presents sublease income separate from the head lease expense. This treatment is consistent with the balance sheet accounting for subleases when the original lessee is not relieved of its primary obligation under the head lease.
If the sublessor is not relieved of its primary obligation under the head lease, however, we believe the sublessor may net sublease income and expense in the income statement. One example of when netting may be acceptable is when the sublessor is subleasing simply to manage occupancy costs and provide flexibility to expand and contract occupancy to meet changing business needs. Assuming the sublessor elects to net, it would present head lease expense net of sublease income.
14.3.3 Lessors: Disclosures
ASC 842-30-50-3 and ASC 842-30-50-7 requires a lessor to disclose the following qualitative items.
A lessor shall disclose both of the following:
a. Information about the nature of its leases, including:
1. A general description of those leases
2. The basis and terms and conditions on which variable lease payments are determined
3. The existence and terms and conditions of options to extend or terminate the lease
4. The existence and terms and conditions of options for a lessee to purchase the underlying asset.
b. Information about significant assumptions and judgments made in applying the requirements of this Topic, which may include the following:
1. The determination of whether a contract contains a lease (as described in paragraphs 842-10-15-2 through 15-27)
2. The allocation of the consideration in a contract between lease and nonlease components (as described in paragraphs 842-10-15-28 through 15-32)
3. The determination of the amount the lessor expects to derive from the underlying asset following the end of the lease term.
A lessor shall disclose information about how it manages its risk associated with the residual value of its leased assets. In particular, a lessor should disclose all of the following:
a. Its risk management strategy for residual assets
b. The carrying amount of residual assets covered by residual value guarantees (excluding guarantees considered to be lease payments for the lessor, as described in paragraph 842-30-30-1(a)(2))
c. Any other means by which the lessor reduces its residual asset risk (for example, buyback agreements or variable lease payments for use in excess of specified limits).
14.3.3.1 Lessors: Sales-type and direct financing leases disclosure
In addition to the general disclosures discussed previously, ASC 842-30-50-9 and ASC 842-30-50-10 require additional disclosures for sales-type and direct financing leases. We do not believe it is necessary to present these disclosures separately for sales-type and direct financing leases.
ASC 842-30-50-9 requires a lessor to disclose significant changes in the balance of its unguaranteed residual assets related to both sales-type and direct financing leases. It also requires a lessor in a direct financing lease to disclose the amount of deferred selling profit.
A lessor shall disclose a maturity analysis of its lease receivables, showing the undiscounted cash flows to be received on an annual basis for a minimum of each of the first five years and a total of the amounts for the remaining years. A lessor shall disclose a reconciliation of the undiscounted cash flows to the lease receivables recognized in the statement of financial position (or disclosed separately in the notes).
A lessor is also required to disclose its lease income in a tabular format in each annual and interim reporting period. For sales-type and direct financing leases, this tabular disclosure should include the following:
- Profit or loss recognized at the commencement date, disclosed on either a gross or net basis based on its business model
- Interest income, either in aggregate or separated by components of the net investment in the lease
- Lease income relating to variable lease payments not included in the measurement of the lease receivable
A lessor should also disclose the components of its aggregate net investment in sales-type leases and direct financing leases including:
- The carrying amount of its lease receivables
- Its unguaranteed residual assets
- Any deferred selling profit in direct financing leases (which is a reduction to the net investment)
14.3.3.2 Lessors: Operating lease disclosure
In addition to the general disclosures discussed previously, a lessor should disclose the following with respect to operating leases:
- A maturity analysis of lease payments, showing the undiscounted cash flows to be received on an annual basis for a minimum of the next five years and the total lease payments to be received in the remaining years. The maturity analysis for operating leases should not be combined with the maturity analysis for sales-type and direct financing leases
- The property, plant, and equipment disclosures required by ASC 360 separate from owned assets held and used by the lessor
A lessor is also required to disclose its lease income in a tabular format for each annual and interim reporting period. For operating leases, this tabular disclosure should include lease income relating to lease payments, including lease income relating to variable lease payments.
If a lessor elects the practical expedient to not separate nonlease components from lease components (discussed in LG 2.4.4.1), it is required to disclose the following:
- Its accounting policy election,
- The class or classes of underlying assets for which it has elected to apply the practical expedient,
- The nature of:
- The lease and nonlease components included within the combined component and
- The nonlease components, if any, that are accounted for separate from the combined component because they do not qualify for the practical expedient, and
- Whether the combined component is accounted for under the Leases or the Revenue guidance
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