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9.7 Build-to-suit leases in transition
Publication date: 31 Jan 2023
us Leases guide
The leases standard provides transition guidance for certain existing build-to-suit arrangements.
A lessee shall apply a modified retrospective transition approach for leases accounted for as build-to-suit arrangements under Topic 840 that are existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements (if an entity elects the transition method in (c)(1)) or that are existing at the beginning of the reporting period in which the entity first applies the pending content that links to this paragraph (if an entity elects the transition method in (c)(2)) as follows:
1. If an entity has recognized assets and liabilities solely as a result of a transaction’s build-to-suit designation in accordance with Topic 840, the entity shall do the following:
i. If an entity elects the transition method in (c)(1), the entity shall derecognize those assets and liabilities at the later of the beginning of the earliest comparative period presented in the financial statements and the date that the lessee is determined to be the accounting owner of the asset in accordance with Topic 840.
ii. If an entity elects the transition method in (c)(2), the entity shall derecognize those assets and liabilities at the beginning of the reporting period in which the entity first applies the pending content that links to this paragraph.
iii. Any difference in (i) or (ii) shall be recorded as an adjustment to equity at the date that those assets and liabilities were derecognized in accordance with (u)(1)(i) or (ii).
iv. The lessee shall apply the lessee transition requirements in (k) through (t) to the lease.
2. If the construction period of the build-to-suit lease concluded before the beginning of the earliest comparative period presented in the financial statements (if the entity elects the transition method in (c)(1)) or if it concluded before the beginning of the reporting period in which the entity first applies the pending content that links to this paragraph (if the entity elects the transition method in (c)(2)), and the transaction qualified as a sale and leaseback transaction in accordance with Subtopic 840-40 before that date, the entity shall follow the general lessee transition requirements for the lease.
For lessees that choose to adjust comparative periods in transition, the lessee should follow the build-to-suit transition guidance for derecognition of assets and liabilities and account for the lease transaction during the look-back period as if the lease had not been accounted for in accordance with the build-to-suit guidance.
Questions LG 9-18 and LG 9-19 discuss accounting for existing build-to-suit transactions under the new leases guidance.
Question LG 9-18
Should lessees account for build-to-suit transactions that existed at transition under the new build-to-suit guidance?
Should lessees account for build-to-suit transactions that existed at transition under the new build-to-suit guidance?
PwC response
The leases standard does not specifically address how the new build-to-suit model in ASC 842 should be applied to build-to-suit transactions that exist at transition. We believe the accounting will depend on the stage of the project.
- If there are no assets and liabilities recognized by the lessee as a result of a completed construction project on the effective date (i.e., the lessee was either not the owner during construction under ASC 840 or the transaction qualified as a sale-leaseback), we believe the lessee should follow the normal lease transition requirements for the lease at the effective date.
- If construction is complete as of the effective date and assets and liabilities have been and still are recognized by the lessee as a result of the construction project as of the effective date, we believe the lessee should derecognize assets and liabilities record solely as a result of the build to suit arrangement pursuant to ASC 842-10-65-1(u)(1). Any difference should be recorded as an adjustment to equity. The lessee would then follow the normal lease transition guidance. Also refer to the response to Question LG 9-19 for additional guidance on these transactions.
- If construction is still in progress as of the effective date, we believe the transaction should be reassessed under the control-based build-to-suit model in the leases standard.
- If the lessee was deemed to be the accounting owner under ASC 840 and is not deemed to control the asset under the new leases standard, the lessee should derecognize the asset under construction and the liabilities recorded solely as a result of applying build to suit lease accounting. Any difference should be recorded as an adjustment to equity. The lessee would then follow the normal lease transition guidance. Also, refer to the response to Question LG 9-18 for additional guidance.
- If the lessee was not previously the accounting owner but is deemed to control the asset under construction under the new leases standard, the lessee should recognize the asset under construction and a liability (A) at the later of (1) the earliest period presented or (2) the date control over the asset under construction was established if the entity chooses to adjust comparative periods or (B) at the effective date if the entity chooses to not adjust comparative periods. A lessee that controls the asset being constructed under the leases standard would also need to assess the transaction under the sale and leaseback provisions of the leases standard upon completion of construction.
- The liability and asset under construction should remain on the balance sheet if the lessee was previously the accounting owner and is deemed to control the asset under the leases standard. A lessee that controls the asset being constructed under the leases standard would also need to assess the transaction under the sale and leaseback provisions of the leases standard upon completion of construction.
Question LG 9-19
Must lessees apply sale and leaseback transition guidance under the leases standard to failed sale and leaseback transactions under ASC 840 that existed prior to the effective date of the leases standard when these transactions resulted from failed build-to-suit transactions under ASC 840?
Must lessees apply sale and leaseback transition guidance under the leases standard to failed sale and leaseback transactions under ASC 840 that existed prior to the effective date of the leases standard when these transactions resulted from failed build-to-suit transactions under ASC 840?
PwC response
Under ASC 840 and the leases standard, a lessee that is deemed to be the owner of a construction project due to a failed build-to-suit transaction must evaluate the transaction upon construction completion to determine if it qualifies for sale-leaseback accounting.
The transition guidance in the leases standard does not explicitly address the transition for a transaction that failed the sale and leaseback guidance under ASC 840 once construction was completed (either prior to or during the look-back period) because the transaction failed the build-to-suit guidance under ASC 840. We believe that in such instances, since the reason for the failed sale-leaseback was due to a failed build-to-suit under ASC 840, the lessee should apply the transition guidance applicable to the failed build-to-suit (i.e., the lessee would not have to apply the sale and leaseback transition guidance for a failed sale and leaseback transaction). Instead, the lessee would derecognize the assets and liabilities recorded solely as a result of transaction’s build-to-suit designation and record any difference as an adjustment to equity (1) at the later of the beginning of the look-back period and the date the lessee was determined to be the accounting owner under ASC 840, if a reporting entity chooses to adjust comparative periods, or (2) at the effective date, if the entity chooses not adjust comparative periods. After such date, the lessee would follow the lessee transition requirements for the lease and record a right-of-use asset and lease liability for the lease.
It is not uncommon for a lessee to capitalize costs due to the application of build to suit that would have also been capitalized were the lessee not the accounting owner. For example, the lessee may have funded part of the construction costs on behalf of the lessor. These costs would be considered prepaid rent and should be reflected as such in transition. Payments for leasehold improvements are another common example of assets that should remain on the lessee’s balance sheet after build to suit assets and debt are removed in transition. Prepaid rent and leasehold improvements would be reflected on the balance sheet at cost (amortized cost when the asset has been placed into service prior to transition.) If the lessee chooses to adjust comparative periods, then we believe the adjustments in those comparative periods would include reversing the income statement effects of the recognition of any imputed ground rent expense recorded during the construction period as well as the interest expense and depreciation expense recognized after construction was complete.
The methodology used for lease classification of the lease recorded upon adoption varies depending on whether or not the lessee elects the package of practical expedients (discussed in LG 9.3.1.1).
- Lessee did not elect the package of practical expedients: In this case, the lessee is reassessing lease classification for all existing leases under ASC 842. Therefore, we believe the lessee should also apply ASC 842 to determine lease classification. The lessee can elect to use either of the following dates to classify the lease:
- Lease commencement date
- the later of (1) the lease commencement date and (2) the date that the lessee first recognizes the lease on the balance (i.e., the ASC 842 application date)
- Lessee elects the package of practical expedients: In this case, the lessee is not reassessing lease classification for all existing leases (i.e., lease classification is based on ASC 840). Therefore, we believe that in addition to the two options listed above, the lessee can also elect to use ASC 840 lease classification guidance and determine lease classification using the lease inception date and the terms and conditions of the lease at that time.
The options listed above should be elected as an accounting policy and must be applied consistently.
PwC. All rights reserved. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. Each member firm is a separate legal entity. Please see www.pwc.com/structure for further details. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors.
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