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In a sublease, an entity is both a lessee and a lessor for the same underlying asset. In a sublease a lessee subleases the underlying asset to a sublessee; the entity is then referred to as the intermediate lessor (or sublessor). In a sublease transaction, the lease between the original lessee and lessor (referred to as the head lease) remains in effect. Figure LG 8-1 illustrates a typical sublease arrangement.
Figure LG 8-1
Typical sublease arrangement
Subleases can arise for many reasons–for example, when a lessee no longer requires leased space and subleases the excess to another party. Another example is when an intermediate lessor leases hardware to its customer (sublessee) bundled with additional goods and services.
See LG 9.2.4, LG 9.2.5, and LG 9.3.2.3 for information on the disclosure requirements for subleases.

8.2.1 Accounting by the intermediate lessor

Subleases of right-of-use assets are within the scope of ASC 842 and should be accounted for in the same way as other leases. The intermediate lessor should separately account for the head lease and sublease unless it is relieved of its primary obligation under the head lease. Typically, a lessee would not be relieved of its obligations under the head lease unless it is contractually replaced in the head lease with the sub lessee. See LG 8.2.1.2 for additional information. See LG 3 and LG 4 for information on the classification and accounting for the head lease prior to the intermediate lessor entering into a sublease.
As discussed in ASC 842-10-25-6, an intermediate lessor should determine the classification of the sublease based on the underlying asset, rather than the right-of-use asset arising from the head lease.

ASC 842-10-25-6

When classifying a sublease, an entity shall classify the sublease with reference to the underlying asset (for example, the item of property, plant, or equipment that is the subject of the lease) rather than with reference to the right-of-use asset.

8.2.1.1 Intermediate lessor retains head lease primary obligation

ASC 842-20-35-14 discusses the accounting for the head lease when an intermediate lessor enters into a sublease and the intermediate lessor is not relieved of its primary obligation under the head lease. Figure LG 8-2 summarizes the accounting for various lease types. ASC 842-20-35-15 specifies that the intermediate lessor should use the rate implicit in the lease to classify the sublease and also measure the net investment in a sublease classified as a sales-type or direct financing lease. If such rate cannot be readily determined, the intermediate lessor should use the discount rate that it originally used to account for the head lease.
Figure LG 8-2
Accounting for a head lease and related sublease when the intermediate lessor is not relieved of its primary obligation under the head lease
Lease classification
Intermediate lessor accounting treatment
Sublease is classified as an operating lease
  • Regardless of whether it is an operating or finance lease, the intermediate lessor should continue to account for the head lease as before commencement of the sublease.
  • If the total remaining lease cost (on the head lease) for the term of the sublease is more than the anticipated sublease income for that same period, this is an indicator that the carrying amount of the right-of-use asset associated with the head lease may not be recoverable. The right-of-use asset should be assessed for impairment in accordance with ASC 360-10-35-21; we believe the lease provisions (e.g., the term of the head lease and sublease) should be considered when assessing whether there is an impairment. See LG 4.6 for guidance on the impairment of a right-of-use asset.
The original lease is a finance lease and the sublease is a sales-type or direct financing lease
  • The original right-of-use asset should be derecognized in accordance with the sales-type lease/direct financing lease derecognition guidance in ASC 842-30-40-1 (see LG 5.7) and the original lease liability should be accounted for as before commencement of the sublease.
  • The intermediate lessor should evaluate its net investment in the sublease for impairment in accordance with the guidance in ASC 842-30-35-3. See LG 4.7 for information on the impairment of a net investment in a lease.
The original lease is an operating lease and the sublease is a sales-type or direct financing lease
  • The original right-of-use asset should be derecognized in accordance with the sales-type lease/direct financing lease derecognition guidance in ASC 842-30-40-1 (see LG 5.7) and the original lease liability should be accounted for based on the accounting for a lease liability in a finance lease (see LG 4). Note that since the sublease met one of the conditions for a sales type or direct financing lease and the head lease did not, the intermediate lessor should evaluate whether the original assumptions relating to the head lease have changed.
  • The right-of-use asset should be evaluated for impairment prior to derecognition using the guidance in ASC 360. See LG 4.6 for information on the impairment of right-of-use assets.
  • After derecognizing the right-of-use asset, the net investment in the sublease is subject to the impairment guidance in ASC 842-30-35-3. See LG 4.7 for information on the impairment of a net investment in a lease.
As discussed in LG 9.3.2, ASC 842-10-15-39A, provides lessors an election to exclude certain lessor costs that are directly remitted by a lessee to a third party from consideration in the contract. A lessor that elects this policy would exclude those payments from gross presentation. We believe an intermediate lessor should similarly present any variable lessor costs, such as property taxes and insurance, that are directly paid by the sublessee to the third-party biller on a net basis (i.e., no effect on the intermediate lessor’s income statement). However, we do not believe this ASU applies to an intermediate lessor when a sublessee makes fixed or variable rent payments to the head lessor (rather than to the third-party biller) on behalf of the intermediate lessor (i.e., the intermediate lessor should separately recognize sublease income and expense under the head lease).
Accounting for the head lease
Subletting a leased asset may trigger remeasurement of the lessee-sublessor’s head lease, and may also require the lessee-sublessor to reassess lease classification of the head lease. For example, upon entering into a sublease, the intermediate lessor should consider whether the sublessee is reasonably certain of exercising an extension option (or not exercising a termination option). If the sublease term exceeds the head lease term, the intermediate lessor will need to update the head lease term to be at least equal to the sublease term, which will require remeasurement and reassessment of the classification of the head lease. See LG 5.3 for information on the remeasurement and reassessment of classification of a lease.

8.2.1.2 Intermediate lessor is relieved of head lease primary obligation

ASC 842-20-40-3 provides guidance on accounting for a head lease and sublease when the intermediate lessor is relieved of its primary obligation under the original lease.

Excerpt from ASC 842-20-40-3

If the nature of a sublease is such that the original lessee is relieved of the primary obligation under the original lease, the transaction shall be considered a termination of the original lease. … Any consideration paid or received upon termination that was not already included in the lease payments (for example, a termination payment that was not included in the lease payments based on the lease term) shall be included in the determination of profit or loss to be recognized in accordance with paragraph 842-20-40-1. If a sublease is a termination of the original lease and the original lessee is secondarily liable, the guarantee obligation shall be recognized by the lessee in accordance with paragraph 405-20-40-2.

See LG 5.5 for more details regarding termination of a lease.

8.2.2 Accounting by the head lessor

As described in ASC 842-30-35-7, a head lessor should continue to account for a lease that an intermediate lessor has subleased, sold, or transferred as it did before such transaction. However, if the lease is replaced by a new agreement with a new lessee, the head lessor should account for the change in lessee as a termination of the original lease and the commencement of a new lease. See LG 5.8 for more details regarding termination of a lease.

8.2.3 Accounting by the sublessee

A sublessee would account for the arrangement similarly to any new arrangement that it enters which is, or contains, a lease. As discussed in LG 3.3.4.6, lessees should discount lease payments at the lease commencement date using the rate implicit in the lease; if the information necessary to determine the rate implicit in the lease is not readily available, a lessee should use its incremental borrowing rate.
While a sublessee should determine its incremental borrowing rate as it would in any lease, questions have arisen about how a sublessee should determine (and whether it can determine) the rate implicit in the lease. This is because there is more than one lessor in a sublease: should the sublessee determine the head lessor’s rate implicit in the head lease (based on the head lessor’s return on the underlying asset), or the intermediate lessor’s rate implicit in the sublease (based on the intermediate lessor’s return on its right-of-use asset, rather than the underlying asset)?
We believe a sublessee should determine a discount rate similarly to how it would do so in any lease. A lessee must use the rate implicit in the lease to measure a lease liability when that rate is readily determinable. Typically, a lessee does not have all the requisite information to readily determine the rate implicit in any lease and it should, therefore, use its incremental borrowing rate to measure the lease liability. However, when the sublease and head lease terms are identical, (e.g., the intermediate lessor and sublessee are common control entities, and the sublease and head lease are coterminous), the sublessee should use the rate implicit in the lease as the rate is readily determinable.
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