Key money and ASC 842. A sublease is defined by both ASC 840 and ASC 842 as a transaction in which an underlying asset is re-leased by the original lessee to a third party, and the lease agreement between the two original parties remains in effect. Lessees will now need to recognize a right-of-use asset and a lease liability upon the inception of a lease. Basically, a payment of key money in this context should become a part of the right of use (ROU) asset, which will then be amortized over the term of the lease. It does not impact the lease liability, because the key money has already been paid. The new ASC 842 and IFRS 16 lease accounting standards are designed to pull leases from the footnotes and onto the corporate balance sheet in an effort to provide more transparency for investors. Applicability. The accounting treatment for the head lease by the original lessee, now the sublessor, is what may change in a sublease. Next, Company A determines whether the sublease is a finance or operating lease. The loss for a direct financing sublease is calculated as the excess of the net investment or carrying amount of the investment in sublease over the expected rental payments and estimated residual value to be received by the lessor. All asset and property leases with lease terms of more than 12 months are recognised under IFRS 16 as a right of use and liability on the balance sheet. With a sublease, the lessor of the head lease will continue to account for their lease the same as before. Sublease accounting The classiication tests under IFRS 16 are with reference to the right-of-use asset, not the underlying asset. Sale leaseback transactions There are signiicant diferences in the treatment of sale and leaseback transactions between the two standards. The amortization schedule for the original lease under ASC 842 is below: At the end of Year 5, Company A determines that it no longer needs the space, and decides to sublease the space to a third party for the remaining 5 years of the lease. A comprehensive example of sublease accounting under ASC 840, 3. When a lessee ceases using a property or piece of equipment under an operating lease agreement, subleases it to a third party, and continues making payments to the lessor, the correct accounting treatment is determined by the lease classification. The building is not customized to the original lessee or the sublessee, such that at the end of the lease it has no value to the lessor. Input will be needed from finance, accounting, tax, real estate, legal and technology. We expect that most subleases under ASC 842 will be classified as operating leases, while most subleases under IFRS 16 will be classified as finance leases by the sublessor. Please see www.pwc.com/structure for further details. Launch. From within the action menu, select the “Copy to iBooks” option. For the United States, FASB is a private, non-profit organization that is responsible for establishing and improving Generally Accepted Accounting Principles (GAAP). The on-balance sheet requirement of the new standard is creating a huge implementation challenge for many companies. Refer to Appendix E of the publication for a summary of the updates. , PwC US, Subscribe to PwC's accounting weekly news. Using the head lease and sublease terms specified above in our comprehensive ASC 840 example, we will walk through an example of sublease accounting under ASC 842. Although ASC 842 removed leveraged lease accounting, leases that met the definition of a leveraged lease under ASC 840 that commenced before the effective date of ASC 842 are grandfathered in. At the end of Year 5, Company A decides that it no longer needs the space, and decides to sublease the space to a third party for the remaining 5 years of the lease, rather than terminate the lease. Further resources. Additionally, the accounting treatment of the sublease by the sublessee will be no different than other leases. 3. One caveat exists – if the total expected sublease income is less than the head lease’s cost for the term of the sublease, the sublessor has an indication that the ROU asset recorded for the original lease may not be recoverable. Terms of the sublease To prepare for the adoption of the new standard, organizations should take measures to educate their lenders and internal associates on the upcoming standards, implement required process changes, and assess the need to implement new software solutions to aide in accounting for leases under ASC 842. Account for the sublease using the established discount rate and according to its lease type. Lease term: 5 years Like our ASC 840 example, let’s assume the original lease is an operating lease. Under IFRS, all leases are classified as finance leases. Finally, once the discount rate and the classification of the sublease have been determined, the sublessor accounts for the sublease in accordance with the applicable lease classification. The US GAAP lease accounting standard, ASC 842, requires that all leases, both operating and finance, are moved on-balance sheet unless the lease term is less than 12 months. The original lessee becomes the sublessor and records lease income from the sublessee, in addition to the lease expense recorded for the head lease. Among other requirements, ASC 842 declared that most … Net presentation of expense and income may be allowed if the criteria for contract combinations are met or subleasing is not a major part of an organization’s business. At the end of Year 5, the present value of the remaining payments Company A owes under the head lease is $40,725 and the book value of the ROU asset is $34,475. Because an ROU asset and lease liability are recorded for an operating lease under ASC 842, sublease accounting for the sublessor is impacted by both the lease classification of the original lease and the lease classification of the sublease. Following the commencement of the sublease, Company A makes the following entry at the beginning of Year 6 to reflect the payment of cash to their lessor and the receipt of cash from Company B for the sublease. As a result, international companies need to maintain two sets of lease calculations for each operating lease, and two sets of balance sheet reconciliations to track liability and asset balances. If the original lease is a capital lease due to title transferring or an existing bargain purchase option, the sublease is classified as any new lease, using the criteria outlined in ASC 840-10-25-1. Future Lease Accounting Standards with ASC 842. However, the calculation of the loss differs for the various lease types: Below are the details of a building lease and the sublease arrangement between Company A, the original lessee and the sublessor, and a third party, the sublessee, to further illustrate the accounting for a sublease under ASC 840. … After years of discussion and a host of draft documents, in January of 2016 the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) each released new mandates related to accounting for leases. Under ASC 840 a sublease agreement may result in updated accounting treatment for the original lease for the lessee. Based on the analysis below, the sublessor classifies the sublease as an operating lease: Once the discount rate and lease classification of the sublease have been determined, the sublessor is able to proceed with accounting for the sublease. Browse our library of on-demand CPE programs. For operating leases, ASC 842 requires recognition of a right of use (ROU) asset and a corresponding lease liability upon lease commencement. For public companies, the ASU is effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018. Establish the discount rate for the sublease. With the tools and insights you'll find here, you can accelerate your project, avoid the pitfalls and become compliant successfully. ASC 842 & IFRS 16 brings some of the most impactful changes to GAAP in quite some time and as organizations scurry to get into compliance, a whole new category of software has been born… Lease Accounting Software. ASC 842 has significantly changed the guidance in determining whether the lessee is the accounting owner of the asset under construction in a built-to-suit lease arrangement. Douglas Sayad, CPA, and William Watts . The transition could prove to be more complicated than many expect, so that extra time can be valuable. 1. In the previous situation, as described in IAS 17 (IFRS) and ASC 840 (FASB), operating lease obligations were not on the balance sheet whereas financing leases were. Board Lease Accounting enables companies to achieve IFRS 16 and ASC 842 compliance with ease, taking care of the entire process of data management, calculation, simulation, and reporting. If the head lease is an operating lease and the sublease is a sales-type or direct financing lease, the sublessor derecognizes the ROU asset from the head lease and records a net investment in the sublease. ASC 842 Overview. Earn CPE and catch up on accounting and financial reporting hot topics at the same time. No transfer of ownership PwC’s Leases guide is a comprehensive resource for lessees and lessors to account for leases under the new leases standard (ASC 842). The US GAAP lease accounting standard, ASC 842, requires that all leases, both operating and finance, are moved on-balance sheet unless the lease term is less than 12 months. Improve transparency and address IFRS 16 and ASC 842 compliance with a solution that is quick to implement and easy to use. KPMG professionals discuss lease accounting impacts of the current economic environment and entities’ related actions, recent FASB lease-related activities, and private entity implementation of ASC 842. Company A will also record annual lease revenue of $10,000 for the 5 years of the sublease. (The term to consider for each is the noncancelable term with any renewals the lessee [or sublessee] is reasonably certain to elect). In sections 842-10-25-1 thru 25-3, a lease is classified as a … The first step in accounting for a sublease under ASC 842 is to determine whether the transaction qualifies as a sublease. CCH Tagetik Lease Accounting is a pre-configured starter kit that provides you with all the functionality to create a centralized repository for lessee, lessor, and sublease information and process lease data of all types – including real estate, fleet, equipment and more. The sublessee may or may not be aware that they are the lessee of a sublease, and therefore the sublease status will have no effect on their accounting treatment of the lease. Assuming a sublease contract was agreed upon with Company B with the terms from above, Company A makes the following entry at the beginning of Year 6 to reflect the payment of cash to their lessor and the receipt of cash from Company B for the sublease: Accounting for subleases under the new accounting standard is similar to legacy accounting, except now the head lease has a ROU asset and lease liability. ASU No. Further resources. Similar to ASC 840, if the original lessee is relieved of its primary obligations, a new lease contract with a new lessee replaces the original lease and termination of the original lease has occurred; not a sublease. share. ASC 842 – deferred but not forgotten. 1.5 CPE credits. 4 FASB ASC 842 Lease Accounting Handbook would drop lease classification and apply what we now know as capital lease accounting, which the Boards refer to as “finance lease accounting—note the name change, to all leases with a term of more than 12 months and leases of small (meaning low value) items can be exempted from capitalization . We’ve got you covered. ASC 842 & IFRS 16 brings some of the most impactful changes to GAAP in quite some time and as organizations scurry to get into compliance, a whole new category of software has been born… Lease Accounting Software. The transition could prove to be more complicated than many expect, so that extra time can be valuable. ; The commencement date would be the date when the lessor makes the underlying asset available for the lessees use. The sublease does not transfer ownership or provide for an option to purchase the underlying asset. If the sublease qualifies for capital lease treatment, the unamortized capital lease asset under the original agreement becomes the cost of the asset being subleased. Webcast overview. The original lease is referred to as the head lease and the new lease with the third party is the sublease. We’ve got you covered. *Note: if the circumstances of the original lease imply that the original lessee acted only as an intermediary to the sublease transaction, the sublease can also be analyzed by the minimum lease payments criterion using the original fair value of the underlying asset. Lease accounting standards changed under IFRS 16 and ASC 842, and alter the way properties, and tangible and intangible assets are recognised for leases. Sale leaseback transactions There are signiicant diferences in the treatment of sale and leaseback transactions between the two standards. Atlanta, GA 30346, A comprehensive example of sublease accounting under ASC 840, Straight-line amortization schedule for the head lease, Accounting for an operating sublease under ASC 840, A comprehensive example of sublease accounting under ASC 842, Operating lease amortization schedule for the initial lease, head lease is a capital lease under ASC 840, sublease is an operating or finance lease, the sublessor will use the rate implicit in the lease, perform the standard finance vs. operating lease assessment, Operating Lease Accounting under the New Standard, ASC 842: Full Example and Explanation, Potential Impairments of Leased Assets and the Right-of-Use Asset, ASC 840 vs ASC 842: Differences between the Old and New Lease Accounting Standard, Right-of-Use Asset and Lease Liability under ASC 842. This is also true for ASC 842, but with some added complexities. The sublessor then accounts for the lease liability of the original lease in accordance with the accounting guidance for finance leases. This guide was fully updated in October 2020. If the head lease is a finance lease and the sublease is a sales-type or direct financing lease, the sublessor derecognizes the ROU asset from the head lease and records a net investment in the sublease. 2016- 02, Leases (Topic 842),to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing transactions. Lease payments: $7,500 annually, paid in advance FASB ASC Lease Accounting 842 Introduction and Quick Links. You’ll examine how the new rules will impact your financial statements, and you’ll gain practical guidance on how to apply the new rules to your company’s reporting situation. 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