NetLease - Non-Lease Components

ASU 2016-02

The practical expedient that allows lessees to account for the non-lease components together with the related lease components must be elected by class of underlying asset. 

Under ASC 842, with operating leases capitalized and services not capitalized, segregated lease and non-lease components can have significant financial reporting consequence.

Many clients are electing the practical expedient to combine components and account for the combined component as a lease component to avoid the allocation process. We recommend this approach despite the fact that the balance sheet impact will be increased along with the likelihood of the lease being classified as financing type. 

Allocation Process Example (from AICPA / Center for Plain English Accounting): 

Operating lease contract stipulates the total fixed payments in the contract are $10,000 per year for 10 years.

• or $100,000 and those payments related entirely to the lease component

The fixed payments are considered commensurate with market prices.

Maintenance services will be provided on that asset (the non-lease component) and will be billed annually at a market-based rate. 

- Regardless of what is stipulated, the Lessee would have to: 

• determine standalone prices for the lease component and the non-lease component
• allocate a portion of both the fixed payments and the variable payments (when incurred) to the lease and non-lease components based on a relative standalone basis

Because the lease component is commensurate with market prices, its standalone selling price is $100,000.

Assume that the Lessee estimates that the standalone selling price of the service component (non-lease component) is $10,000.

- For the fixed payments, $91,000 would be used as the basis for the lease liability (before discounting)

- $9,100 of lease cost would be recognized annually on a straight-line basis for 10 years

- Assuming that the Lessee recognizes the maintenance services on a straight-line basis throughout the lease term, it will recognize $900 of maintenance expense per year

Many will be tempted to assume that the contractually stipulated amounts of $10,000 would be allocated to lease costs and $1,000 to maintenance expense

• for the variable payments, assume that the Lessee incurs the obligation to make variable lease payments at the end of each year. At the end of Year 1, $1,000 of maintenance services are charged by the Lessor to the Lessee
• The Lessee will allocate 91% or $910 to lease cost and 9% or $900 to maintenance expense
• In total for Year 1, the Lessee would allocate $10,010 to lease cost and $990 to maintenance expense