Page 139 - pwc-lease-accounting-guide_Neat

Accounting for leases

lease is assumed to be the fair value of the underlying asset unless the present value of the lease
payments is lower than the fair value of the asset. This could be the case when the lease has an
unguaranteed residual asset that reduces the receivable recognized at lease commencement. This
should not have a significant impact on the selling profit or loss, however, because the present value of
the unguaranteed residual asset is also subtracted from the carrying amount of the underlying asset
(i.e., a cost of sales). See Example 4-7 for an illustration of how to calculate selling profit when a lease
contains an unguaranteed residual value.

Substantial variable payments

It is common for suppliers in certain industries to structure transactions with significant variable
payments. Suppliers in these industries are willing to accept variability in payments because they
believe such arrangements would be profitable overall and lower fixed payments can make an
arrangement attractive to the customer.

There are instances when transactions with significant variable payments may qualify as a transfer of
control to the customer under the new revenue recognition standard (ASC 606). Such transactions
may also qualify as a sales-type lease under the new leases guidance. This is because the revenue
standard states that the transfer of title is only one of the indicators for control being transferred to a
customer.

Whether a transaction with variable payments is subject to the revenue guidance or the leases
guidance may impact when revenue is recognized by a supplier. Under the leases standard, variable
payments that do not depend on an index or rate are not recognized until the contingency is resolved.
Under the new revenue recognition standard, variable payments may be recognized as revenue
upfront (when earned) provided certain conditions are met.

When a transaction with significant variable payments qualifies as both a sale under the new revenue
recognition standard and a lease under the new leases standard, the leases standard should be applied,
unless the practical expedient discussed in LG 2.4.4.1 is elected and the entire transaction is accounted
for under the ASC 606 revenue standard. Under the lease classification criteria, it is possible for lease
arrangements with significant variable lease payments to be classified by lessors as a sales-type lease.
This may lead to the recognition of an initial loss by the lessor even if the overall arrangement is
expected to be profitable. See Example 4-9 for an illustration of a lease with significant variable
payments.

Presentation

Lease classification does not determine how selling profit or loss should be presented in a lessor’s
income statement. Presentation should be determined by the lessor’s business model; when leases are
used as an alternative means of realizing value from the goods that it would otherwise sell, a sales-type
lease should be recorded as revenue and cost of goods sold. See LG 9.3.2.1 for information on the
presentation of selling profit or loss in the statement of comprehensive income.

4.3.1.2 Initial direct costs

The guidance for identifying initial direct costs is the same for a lessor as it is for a lessee. Additionally,
the term “initial direct costs” under the new leases guidance is the same as incremental costs of
obtaining a contract under the new revenue guidance. The two terms are intended to be applied in the
same manner in terms of which costs get capitalized.

4-16