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9.2 Lessees: Presentation and disclosure
Publication date: 31 Jan 2023 (updated 31 Jan 2021)
us Leases guide 9.2
Although a lessee is required to present assets and liabilities for all leases in a similar manner, presentation of expenses and cash flows will differ based on how a lease is classified.
9.2.1 Lessees: Balance sheet presentation
As discussed in ASC 842-20-45-1, a lessee should separately present a right-of-use asset and lease liability.
A lessee shall either present in the statement of financial position or disclose in the notes all of the following:
a. Finance lease right-of-use assets and operating lease right-of-use assets separately from each other and from other assets
b. Finance lease liabilities and operating lease liabilities separately from each other and from other liabilities.
Right-of-use assets and lease liabilities shall be subject to the same considerations as other nonfinancial assets and financial liabilities in classifying them as current and noncurrent in classified statements of financial position.
9.2.1.1 Right-of-use asset balance sheet presentation
Financial statement users may view right-of-use assets differently than other assets; therefore, finance lease and operating lease right-of-use assets should either be presented separately from each other and other assets on the balance sheet or disclosed in the notes to the financial statements along with the balance sheet line items in which those assets are included.
Although ASC 842-20-45-1 permits disclosure in the notes in lieu of separate presentation on the balance sheet, ASC 842-20-45-3 prohibits combining finance lease and operating lease right-of-use assets on the balance sheet.
As noted in LG 4.2.2.2, initial direct costs should be included in the initial measurement of the right-of-use asset.
There are certain situations that could cause an individual right-of-use asset to have a negative balance. If this occurs, the negative balance should be presented as a liability separate and apart from the lease liability.
Right-of-use assets are subject to the same considerations as other nonfinancial assets, such as property, plant, and equipment, in classifying them as current or noncurrent in a classified balance sheet. Consistent with the classification of property, plant, and equipment, the right-of-use asset should generally be classified as non-current for the entire lease term. A right-of-use asset recorded for a lease with an initial term of 12 months or less (i.e., the short-term lease measurement and recognition exemption was not taken) may be classified as current similar to other executory contracts.
9.2.1.2 Lessees: Presentation of finance and operating lease liabilities
Finance lease and operating lease liabilities should be presented separately from each other and from other liabilities on the balance sheet or disclosed in the notes to the financial statements along with the balance sheet line items in which those liabilities are included. Although ASC 842-20-45-1 permits disclosure in the notes in lieu of separate presentation on the balance sheet, ASC 842-20-45-3 prohibits combining finance lease and operating lease liabilities on the balance sheet.
9.2.1.3 Current versus noncurrent classification of the lease liability
Lease liabilities are subject to all of the same considerations as debt instruments in classifying them as current or noncurrent in a classified balance sheet. See FSP 12 for general debt classification guidance. The lease liability essentially functions as an amortizing loan FSP 12.8 provides guidance for these types of liabilities.
Classification of the lease liability as current or noncurrent is complicated if the lease incentive to be received within one year from the balance sheet date exceeds the lease payments due within that same period. As discussed in LG 3.3.4.2, an in substance fixed lease incentive that is expected to be received after lease commencement should be included when measuring the lease liability. This generally occurs when a lessor agrees to reimburse the lessee for leasehold improvements. For example, if within one year of the balance sheet date, there is a lease incentive of $1,000,000 that will be received and the total lease payments to be paid during that period are $800,000, there would be a net $200,000 inflow. This raises a question about what amount of the lease liability, if any, should be presented in current liabilities since the net amount for the period is an inflow. The cash inflows contemplated under the lease are included in the measurement of the overall lease liability and should not be netted against other current liabilities unless permitted by other applicable literature. In this case, no payments are required in the next 12 months (because there is a net cash inflow) so the entire lease liability is reflected as noncurrent.
9.2.2 Lessees: Income statement presentation
ASC 842-20-45-4 discusses lessee presentation in the income statement.
In the statement of comprehensive income, a lessee shall present both of the following:
a. For finance leases, the interest expense on the lease liability and amortization of the right-of-use asset are not required to be presented as separate line items and shall be presented in a manner consistent with how the entity presents other interest expense and depreciation or amortization of similar assets, respectively.
b. For operating leases, lease expense shall be included in the lessee’s income from continuing operations.
9.2.2.1 Lessees: Finance lease income statement presentation
Reporting entities must present interest expense on the lease liability and amortization of the right-of-use asset in a manner consistent with how these costs are presented for other acquisitions of financed assets since they are economically similar. Therefore, interest expense on the lease liability should be presented with other interest expense in the income statement and amortization of the right-of- use asset should generally be presented with depreciation and/or amortization expense in the income statement.
9.2.2.2 Lessees: Presentation of variable lease payments
ASC 842 does not explicitly address whether variable lease payments made for a finance lease should be presented as lease expense (i.e., an operating expense) or interest expense in the income statement. 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 finance lease, no lease liability would be recorded; in this case, it would be difficult to support presentation of the variable payments as interest expense given there is no liability associated with the lease.
9.2.2.3 Lessees: Operating lease income statement presentation
A lessee should present the lease expense of an operating lease as a single operating expense in income from continuing operations. As noted in LG 4.4.2, lease expense should generally be calculated on a straight-line basis. Although a lessee is not required to provide the components of lease expense, financial statement users will be able to derive certain information from the quantitative disclosures, including the weighted average discount rate. See LG 9.2.5 for further discussion.
9.2.3 Lessees Statement of cash flows presentation
The following subsections address how a lessee should present cash payments for finance and operating leases in the statement of cash flows.
9.2.3.1 Lessees: Finance lease statement of cash flows presentation
A lessee should classify cash payments with respect to finance leases as follows:
- Cash payments for the principal portion of the lease liability arising from a finance lease should be classified as financing activities
- Cash payments for the interest portion of the lease liability arising from a finance lease should follow the guidance in ASC 230. These amounts would generally be classified as operating activities
- Variable lease payments and short-term lease payments not included in the lease liability should be classified as operating activities
- Payments for pre-paid rent for a finance lease are investing activities
9.2.3.2 Lessee: Operating lease statement of cash flows presentation
A lessee should generally classify cash payments arising from operating leases within operating activities. The exception to this relates to lease payments associated with the cost to bring another asset to the condition and location necessary for its intended use that are capitalized as part of the cost of the asset. For example, certain lease payments incurred while building property, plant, or equipment would be capitalized and should be classified as investing activities rather than operating.
Under ASC 842, if a lessee is using the indirect method, both a right-of-use asset and lease liability are recorded as separate line items on the balance sheet for operating leases. The combined change of the two accounts will generally equal the difference between the straight-line lease expense and the cash paid for leases. Questions have arisen as to whether a single line presentation in the reconciliation to net income is appropriate with the two line items on the balance sheet. ASC 842 does not explicitly address this question. Additionally, the general statement of cash flow guidance in ASC 230 provides limited guidance on applying the indirect method. However, ASC 230 does suggest that the reconciliation of net income to operating cash flows should separately report all major classes of reconciling items. Therefore, we believe that the changes in right-of-use assets and lease liabilities arising from lease expense should be reported separately. This is consistent with the balance sheet presentation. One way to present this is to separately present the amortization of the right-of-use asset as a non-cash adjustment from net income and the change in the lease liability due to cash payments as a change in operating assets and liabilities.
We are also aware of another view of presenting a single line item in the reconciliation similar to how it was presented under ASC 840. Given the lack of guidance in this area and that the leases standard does not require the separate presentation of the expense in the income statement, we believe a single-line presentation in the reconciliation would be acceptable.
9.2.3.3 Lessees: Payments and reimbursements for leasehold improvements
As discussed in LG 3.3.4.2, when a lessee pays for an improvement to the leased property, it must determine whether the improvement is a lessee asset or a lessor asset.
In the statement of cash flows, payments made by a lessee for lessee assets are reflected as investing activities. If the lessor reimburses the lessee for lessee assets, the reimbursement is treated as a lease incentive and the statement of cash flow presentation is the same as any other lease payment. For example, a lease incentive received for an operating lease would be an operating activity.
If a lessee pays for a lessor asset, the payment is accounted for as prepaid rent. If the lessor reimburses the lessee for the lessor asset, it is recorded as a reduction to the prepaid rent. For payments made by a lessee that are accounted for as prepaid rent, we believe that the statement of cash flows presentation will depend on the expected lease classification at commencement. If there is clear evidence that the lease would be classified as a finance lease, the prepayment should be reflected in the investing section of the statement of cash flows. Otherwise, the prepayment should be reflected in the operating section of the statement of cash flows. After the commencement date, any payments made by a lessee and any subsequent reimbursement by the lessor should follow the classification of any other lease payments in the statement of cash flows.
9.2.3.4 Lessees: Noncash transactions
As discussed in LG 9.2.5, ASC 842 requires certain quantitative disclosures. One such disclosure relates to supplemental noncash information on lease liabilities arising from obtaining right-of-use assets. Furthermore, ASC 230 requires disclosure of all non-cash investing and financing transactions. We believe that all noncash transactions related to adjustments to the lease liability or right-of-use asset should be disclosed as noncash transactions. This includes all noncash changes related to any modification or reassessment events (even when there is a decrease to the right-of-use asset). We believe that disclosing each type of noncash event is the most transparent disclosure, however, we would not object to presenting all changes in one non-cash line item.
9.2.4 Lessees: Qualitative disclosures
ASC 842-20-50-3 requires a lessee to disclose the following qualitative items.
A lessee shall disclose all 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. A lessee should provide narrative disclosure about the options that are recognized as part of its right-of-use assets and lease liabilities and those that are not.
4. The existence and terms and conditions of residual value guarantees provided by the lessee.
5. The restrictions or covenants imposed by leases, for example, those relating to dividends or incurring additional financial obligations.
A lessee should identify the information relating to subleases included in the disclosures provided in (1) through (5), as applicable.
b. Information about leases that have not yet commenced but that create significant rights and obligations for the lessee, including the nature of any involvement with the construction or design of the underlying asset.
c. 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 discount rate for the lease (as described in paragraphs 842-20-30-2 through 30-4).
For more information about the significant assumptions and judgments noted in paragraphs ASC 842-20-50-3(c)(1) through ASC 842-20-50-3(c)(3), see LG 2.3, LG 2.4, and LG 3.3.4.6.
Lessees should disclose the election of the short-term lease measurement and recognition exemption (see LG 2.2.1). Additionally, if the short-term lease expense for the period does not reasonably reflect the lessee's ongoing short-term lease commitments, a lessee should disclose that fact and the amount of its short-term lease commitments.
Example LG 9-1 illustrates a disclosure requirement around short-term lease expense and on-going short-term lease commitments
EXAMPLE LG 9-1
Short-term lease expense for the period does not reasonably reflect on-going short-term lease commitments
Short-term lease expense for the period does not reasonably reflect on-going short-term lease commitments
Lessee Corp elects to apply the short-term lease measurement and recognition exemption to its office equipment. For the majority of the reporting period ending 12/31/X8, there were only two short-term leases in that class. However, on 12/27/X8, Lessee Corp enters into 20 new lease agreements for office equipment and they all qualify for the short-term lease measurement and recognition exemption. The short-term lease expense for the reporting period ending 12/31/X8 was $300,000, but the total short-term lease payments for the following year will be $3,000,000.
Is Lessee Corp required to disclose the fact that the short-term lease payments will change in the following year?
Analysis
Yes, Lessee Corp must disclose the $3,000,000 commitment because the $300,000 of short-term lease expense recorded in the current period does not reasonably reflect its on-going short-term lease commitments.
9.2.4.1 Discount rate for lessees that are not public business entities
ASC 842-20-30-3 permits lessees that are other than public business entities to apply a risk-free discount rate by class of underlying asset. . An eligible lessee that makes this policy election should disclose the election and the class or classes of underlying assets to which it has been applied. See LG 3.3.4.6 for more information about this election
9.2.5 Lessees: Quantitative disclosures
The leases standard also requires a lessee to disclose certain quantitative items as discussed in ASC 842-20-50-4.
For each period presented in the financial statements, a lessee shall disclose the following amounts relating to a lessee’s total lease cost, which includes both amounts recognized in profit or loss during the period and any amounts capitalized as part of the cost of another asset in accordance with other Topics, and the cash flows arising from lease transactions:
a. Finance lease cost, segregated between the amortization of the right-of-use assets and interest on the lease liabilities.
b. Operating lease cost determined in accordance with paragraphs 842-20-25-6(a) and 842-20-25-7.
c. Short-term lease cost, excluding expenses relating to leases with a lease term of one month or less, determined in accordance with paragraph 842-20-25-2.
d. Variable lease cost determined in accordance with paragraphs 842-20-25-5(b) and 842-20-25-6(b).
e. Sublease income, disclosed on a gross basis, separate from the finance or operating lease expense.
f. Net gain or loss recognized from sale and leaseback transactions in accordance with paragraph 842-40-25-4.
g. Amounts segregated between those for finance and operating leases for the following items:
1. Cash paid for amounts included in the measurement of lease liabilities, segregated between operating and financing cash flows
2. Supplemental noncash information on lease liabilities arising from obtaining right-of-use assets
3. Weighted-average remaining lease term
4. Weighted-average discount rate.
The amount of lease cost will not always be the same as the lease expense recognized. Lease cost may include items not recognized as lease expense (e.g., amounts capitalized as part of the cost of inventory).
A lessee should also disclose a maturity analysis of its finance lease and operating lease liabilities, separately showing:
- The undiscounted cash flows on an annual basis for a minimum of each of the next five years
- The sum of the undiscounted cash flows for all years thereafter
- A reconciliation of the undiscounted cash flows to the discounted finance lease liabilities and operating lease liabilities recognized in the statement of financial position
ASC 842-20-55-53 provides an example of this disclosure requirement.
9.2.6 Lessees: Interim disclosures
There are no specific interim disclosure requirements in ASC 842 for lessees. However, ASC 270, Interim Reporting, requires reporting entities to report significant changes in financial position, accounting principles, and estimates along with other information that helps users understand how the interim financial reporting results compare with those for its most recent annual period. Therefore, reporting entities should consider disclosing leasing events that have a significant impact on the interim financial statements compared to the previous year end. However, reporting entities may elect to provide interim lease disclosures in a manner consistent with its annual financial statements if its leasing activities are significant. Refer to FSP 29 for additional details related to interim financial reporting.
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