In this article, we will look at the non-lease component of a lease contract from the lessee’s perspective. Up to now, we have been discussing a lease contract on the assumption that it is only a contract for the borrowing and lending of goods. In fact, in addition to the components that stipulate the rights and obligations to borrow and lend things, there are many other matters that are agreed between the lessor and lessee, such as maintenance of the leased property, management and maintenance of common areas of real estate, and tax burdens. In the new lease accounting, these matters are treated as lease components, non-lease components, or non-components. To avoid confusion with a “lease contract” that includes only a lease component, a contract that includes multiple components and noncomponents will be referred to as a lease arrangement in this article.
Elements of a Lease Arrangement
Lease component
This is the portion of a lease arrangement that grants the right to use the asset to be leased.
Nonlease component
This is the part of a lease arrangement that transfers some goods or services that are not directly related to the right to use the leased asset. An example s the Common Area Maintenance (CAM) cost-sharing arrangement in the case of a real estate lease.
Noncomponent
ASC 842 defines a noncomponent as the portion of a lease arrangement that does not transfer any goods or services.
- “Administrative tasks to set up a contract or initiate the lease that do not transfer a good or service to the lessee.” This is primarily a cost from the perspective of the lessor.
- “Reimbursement or payment of the lessor’s costs.” This is a cost from the perspective of the lessee in that the lessee reimburses or pays directly to a third party (g., tax authority) for a cost that lessor incurs as the owner of the asset. Such burdens do not transfer any goods or services to the lessee.
Separation of multiple lease components
When analyzing a lease arrangement, the above-mentioned lease component, non-lease component, and noncomponent should be determined. For the lease component, it is necessary to determine whether there are multiple lease components based on the following criteria (ASC 842-10-15-28).
- Lessee may benefit from the use of the leased asset alone or in combination with the leased asset and the resources readily available to the lessee.
- The use of the leased asset is not highly interdependent or integrated with the use of other leased assets.
Specific examples of cases where the above considerations should be made are when a building and furniture are rented together, or when construction equipment, such as a crane and a truck, are rented at one time.
Notwithstanding the above provisions (even if conditions (1) and (2) above are not met), if land is a leased asset, the land component should be treated as a separate lease component from the lease of the building, etc., unless the land component is insignificant (ASC 842-10-15-28). This is because land is a non-depreciable asset and should be treated differently.
Allocation of the transaction price to each component
ASC 842 requires lessees to prorate the transaction consideration between each lease component and non-lease component (ASC 842-10-15-33). It should be noted that variable payments are not included in this transaction consideration (ASC 842-10-15-35).
Specifically, the consideration is divided proportionally between the lease component and the non-lease component at the stand-alone price. The stand-alone price should be the observable one, and if the observable one is not readily available, the stand-alone price should be estimated. When the variability of the stand-alone price of a certain element is high or uncertain, the “residual estimation approach” is acceptable. This is an approach in which, if the stand-alone price of another element is observable or can be estimated, the remaining amount is used as the stand-alone price of the highly variable or indeterminate element.
Fixed payments related to non-components will be prorated to each component, and no consideration will be allocated to non-components.
Here is a simple example
[Example 1] Suppose that the lease arrangement includes a fixed amount of payments for the entire lease term as follows.
| Building lease | $1,600,000 |
| Property tax | $150,000 |
| CAM | $150,000 |
Assume that the Standalone Price is the building lease $1,800,000 and the CAM $200,000. The proration of consideration $1,900,0000 is as follows.
| Building lease | $1,710,000 |
| CAM | $190,000 |
As mentioned above, if a component or non-component is a variable amount rather than a fixed amount, it is excluded from the consideration (consideration) to be prorated.
The following is the result
[Example 2] Suppose a lease arrangement has fixed and variable payments for the entire lease term as follows.
| Building lease | $1,600,000（fixed） |
| Property tax | variable |
| CAM | $150,000（fixed） |
Assume that the Standalone Price is $1,800,000 for the building lease and $200,000 for the CAM.
Consideration is $1,750,000, and the proration is as follows.
| Building lease | $1,575,000 |
| CAM | $175,000 |
In this case, if the variable property tax payment is $15,000 per year, that amount would not be included in the calculation of ROU asset or lease liability, and 90% of the payment would be prorated to lease expense and 10% to maintenance expense on each year’s income statement.
practical expedience that does not distinguish between lease and non-lease components
ASC 842 permits a lessee to choose the practical expedience for allocating the transaction consideration, which does not distinguish between lease components and non-lease components for each class of underlying assets (ASC 842-10-15-37). The practical expedience, which does not distinguish between lease components and non-lease components, is allowed to be selected as the accounting policy for the allocation of transaction consideration. Please refer to the explanation of “Use of risk-free discount rate (practical expedience)” in Part 4 for the “class of underlying assets”.
Specifically, they are as follows
[Example 3] Suppose the lease arrangement includes a fixed amount of payments for the entire lease term as follows.
| Building lease | $1,600,000 |
| Property tax | $150,000 |
| CAM | $150,000 |
Suppose that the practical expedience adopted that does not distinguish between lease components and non-lease components.
In this case, the $1,900,000 consideration is allocated to the building lease, which is the lease component.
[Example 4] If the practical expedience is used in the case of [Example 2] above, the consideration is $1,750,000, all of which is allocated to the building lease as a lease component.
Please note that the simplified method does not allow for multiple lease components to be combined into one.
Relationship to Part 5 “Lease Payments”
The consideration allocated to the release component based on the above classification and prorating method constitutes the lease payment as explained in Part 5. The same applies when the simplified method is used and the portion corresponding to the non-lease component is allocated to the lease component (ASC 842-10-30-6). Therefore, the simplified method saves time and effort because there is no need to account for CAM separately. However, it is necessary to consider the possibility that the lease would be classified as a financial lease and that the ROU asset and the lease liability will be inflated.
Relationship to ASC 840 executory costs
Under the previous standard, the term ” executory costs” included insurance, maintenance, taxes, etc., which are not included in the minimum lease payment (ASC 840-10-25-5). Executory costs were not clearly defined, but they were explained as costs incurred in holding and operating the leased asset.
ASC 842 does not take the position that this executory cost is not included in the lease payment, but instead distinguishes between non-lease components and non-components, and includes them in the lease payment in some cases.
In the next article, we will discuss the treatment of initial direct costs.
