Lessor accounting under the new leasing standard

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Video , PwC US Jul 19, 2016

Is leasing your business? The new leasing standard makes changes to the accounting that will affect the leasing landscape. Watch this video for key changes from the Lessor’s point of view. Hear Jonathan Rhine discuss the impact on Lessors, including classification, sale and leaseback transactions, initial direct costs, and more.


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Hi, I’m Jonathan Rhine.

There’s a lot of talk in the market about the new leasing standard. The new lessor model is substantially similar to current guidance. Limited changes, however, were made to align the leasing guidance with the new revenue guidance and also to make lessor and lessee accounting more symmetrical.

Changes to the lessee model were more significant, so despite only modest accounting changes for lessors, the new standard could have a commercial impact if customers seek to change commonly understood terms and mitigate where possible the financial statement impact of the new guidance.

Let’s discuss three of the changes made to lessor accounting:

  1. Classification
  2. Sale and leaseback transactions, and
  3. Initial direct costs.

Let’s begin with classification. While lessors will continue to classify leases as either operating, direct financing, or sales-type, there are some changes to classification worth noting. The new standard removes the 75% and 90% bright-lines from the lease classification criteria, making the criteria more principles based. That said, the numeric thresholds are included in the basis for conclusions as a reasonable approach to applying the standard. The new standard also eliminates guidance for leveraged leases, although companies will be able to continue using the current accounting model for existing arrangements. Finally, the process for determining whether a lease is a sales-type lease or a direct financing lease will also change. Under new guidance an arrangement is a direct financing lease in certain situations when the lease would otherwise be an operating lease, but the lessor obtains residual value insurance from an unrelated third party.

The second change relates to sale and leaseback guidance. Previously, only the lessee had to evaluate whether an arrangement qualified as a sale. Sale and leaseback accounting as revised now applies not only to the seller lessee, but also to you, the buyer-lessor.

This new sale and leaseback guidance also replaces the prescriptive rules in current literature with a more principle based approach. For the seller to reflect a sale, and for you the buyer to reflect a purchase, a transaction must transfer control of the asset in accordance with the new revenue recognition standard. If the seller-lessee has a repurchase option and it’s not the asset’s fair value at the time it would be exercised, the transaction would not qualify as a sale. A transaction would also often not qualify as a sale, if the repurchase option is for a unique asset. This is important because real estate assets are generally considered unique and so a repurchase option on real estate  would generally preclude sale and leaseback accounting.

Determining whether control has transferred will require judgement. If the criteria are met, the buyer-lessor would recognize the purchased asset on its books. If not, the buyer-lessor will reflect the transaction as a financing, or a note receivable.

Finally, let’s discuss initial direct costs. Under current guidance, lessors often capitalize the initial direct costs to obtain a lease. These might include internal costs, such as evaluating the potential lessee’s financial condition, or external costs, such as paying commissions to brokers. Under the new guidance, only incremental costs, that would not have been incurred without entering into the lease, may be capitalized. This is likely to mean, fewer costs will be capitalized by lessors. While lessors may still defer commissions, or early termination payments to existing tenants, lessors will need to expense as incurred other costs, such as payroll, which are not incremental. They would also need to expense costs incurred during negotiations, for example those made to counsel, presuming those costs would be incurred even if the lease was not signed. Initial direct costs will also need to be included when calculating the implicit rate, so that the lessor recognizes income using a constant rate of return.

While the changes affecting lessors are more modest, this doesn’t lessen the impact they may have. Lessors may find that to comply with the new guidance updates are required to their existing processes, and additional judgements are necessary.

A wealth of additional information, can be found on the Lease accounting topic page, available on CFOdirect.com.

Contact us

Heather Horn

Heather Horn

US Strategic Thought Leader, National Professional Services Group, PwC US

David Schmid

David Schmid

International Accounting Leader, National Professional Services Group, PwC US

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