Lessors should be aware of these interactions when adopting both the new leasing and revenue standards. Hear PwC’s Justin Frenzel share two interactions where the new leasing standard can impact the timing and amount of revenue lessor’s can recognize. First, when a lease contract includes both lease and nonlease components; and second, when variable consideration exists.
Hi, I’m Justin Frenzel.
Virtually all companies are affected by the new leasing and revenue standards. While these standards are separate, there are interactions between the two you may not be aware of. Today, I want to share two interactions we are seeing where the new leasing standard can impact the timing and amount of revenue Lessor’s can recognize. First, when a lease contract includes both lease AND nonlease components; and second, when variable consideration exists. These two areas are fundamentally based on the characteristics of the contract which dictates the appropriate guidance to follow and when to recognize revenue.
Let me start with the impact of lease and nonlease components by using a real estate example. Consider an office lease where the lessor provides the lessee with the right to use space in an office building and also provides common area maintenance services - things like general cleaning and landscaping - all for a fixed monthly fee of $10,000. In this example, the lessee’s right to use, control and benefit from the office space represents a lease component, while the common area maintenance service, which provides goods and services unrelated to securing the use of the office building, represents a non-lease component. For lessee’s, the allocation of consideration between lease and nonlease components is based on the relative standalone price. This will determine the amount of lease payments to include when classifying the lease between financing and operating, and measuring the right of use asset and lease liability.
For lessors, the allocation of consideration is based on the transaction price allocation guidance in the revenue standard. In our example, this would mean the lessor is required to allocate the monthly fee of $10,000 between the lease and nonlease components based on the relative standalone selling prices of each component. If the lessor concluded the standalone selling price to lease the office building and provide common area maintenance services was $9,000 and $1,000, respectively; rent of $9,000 would be accounted for under the leasing standard while the $1,000 for the nonlease component for the common area maintenance would follow the revenue standard.
The second scenario relates to variable consideration. Under lease accounting, variable consideration based on an index or rate is included in contract consideration when classifying and measuring the lease, while other variable consideration is generally excluded. However, revenue recognition guidance permits the inclusion of variable consideration under certain circumstances. What this means is that variable consideration that falls under lease accounting will generally be recognized over the lease term, while if it falls under the revenue guidance it may be recognized earlier.
When variable consideration is identified, you need to determine what the payments relate to. If the variable payments relate entirely to the nonlease component, they’re estimated and included in the transaction price under the new revenue standard. In contrast, if variable payments relate even partially to the lease component they’re allocated between the lease and nonlease components and recognized in accordance with the leasing and revenue standards, respectively.
These conclusions also impact subsequent accounting. If variable payments relate solely to a nonlease component, which typically results in applying the revenue standard, the estimate of variable consideration should be updated each reporting period. However, if variable payments relate even partially to a lease component, which falls under lease accounting, the way you recognize revenue is unchanged, meaning you continue to allocate variable payments between the lease and nonlease components and recognize revenue in accordance with the leasing and revenue standards, respectively.
So as you can see, determining whether a contract includes lease and nonlease components, particularly when variable consideration exists, not only impacts the accounting guidance to follow, but also may affect the timing and amount of revenue to recognize.
© 2016 - 2017 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.