This course is the third course in the five-course Financial Reporting Specialization. This course begins with a discussion of current liabilities and contingencies and continues with long-term debt and bonds. The course next explores accounting model for leases, both lessees and lessors, and a discussion on deferred tax assets and liabilities. Participants will learn the latest accounting standards including the new accounting model for leases effective for public companies in 2019 and private companies in 2020.
Multiple Elements Example
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En provenance du cours de University of Illinois at Urbana-Champaign
Accounting Analysis II: Measurement and Disclosure of Liabilities
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University of Illinois at Urbana-Champaign
6 notes
Cours 3 sur 5 dans Specialization Financial Reporting
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Module 5: Lease Accounting Part 2
In this module, we continue the discussion of the new lease accounting model. You will learn how to account for lease modifications and terminations. The accounting for lease and non-lease elements will be examined. The module then describes the accounting for lessors including sales-type, direct-financing, and operating leases. Our discussion of lease accounting concludes with the accounting for sales and leasebacks.
Rencontrer les enseignants
John HeppClinical Assistant Professor of Accountancy
Department of Accountancy
Welcome back. In this lesson,
we'll go through a few examples of multiple elements in the accounting form.
So remember that non-lease elements within a lease are not recognized as
right of use assets and lease obligations and those could be services,
it can be maintenance, it can be other goods.
So, if you have a printer contract which include the toner,
you wouldn't include the search for toner in there.
You can see that sometimes with medical equipment, with consumables,
you're not going to include those in the lease payment,
you're going to account for those as a separate element.
The right of use asset is supposed to be purely for the use of a tangible asset.
So here's an example,
Devo demolition leases a bulldozer, a truck,
and a crane to Clark engineers to be
used in Clark's construction operations for the next three years.
They also require the lessee to enter
into a contract to maintain each piece of equipment.
They're not going to leave it up to the lessee to do it.
It's required to do it so that there is total consideration in the contract to
600,000 and it's payable in annual installments of 200,000.
So, quick analysis, there's potentially six elements here.
You could have three separate lease elements and three related maintenance services.
Why is the equipment three separate elements?
Well, if the equipment can be used on its own without the other equipment,
it would be a separate element.
You only combine those elements if the answer you get is not
materially different from the answer that you would
get by accounting for them separately.
But for this analysis,
we're going to account for them separately.
So both the lessor and lessee are
concluding that there are six elements because the machines are not highly
interrelated and the lessee can benefit from
each piece of equipment on its own and the $600,000 of
consideration will be allocated to each of
the elements: three pieces of equipment, three maintenance contracts.
So we're going to assume that we have standalone prices available that we can find
other suppliers that provide equipment and
maintenance services for similar equipment on a standalone basis.
In that way, there will be observable prices.
We won't have to get into estimating prices or using a residual
even though Devo demolition doesn't offer them separately.
So it's not necessary that the lessor offer
those services separately to have a standalone prices,
price, we can look to the marketplace or we can
estimate them using a couple of
different methods that are provided for within the standard.
So let's go assuming that we have standalone prices and do the calculation.
So how do we allocate the overall expense in
this contract between the lease elements and the non-lease elements, the maintenance?
And then, within each element of the lease elements,
how do we allocate to the individual equipment both
for the right of use asset for the equipment and the maintenance of that equipment?
Well, it all starts with the standalone selling
prices for the equipment and for the maintenance.
This is a lease, standalone lease price without maintenance,
which is available from other people not even though it's not
available from the particular lessor in this problem,
and the standalone price for the maintenance.
And we're going to take the ratio between those two.
So the ratio between this here,
we have the standalone selling price would be
80 percent of the total and 20 percent of the total for maintenance,
and we're going to take that ratio and we're going to multiply it times
the total payments in this contract and we're going to
allocate $480,000 to the lease element and $120,000 to the non-lease element.
So lets scroll down.
We can see the percentages that we now have for each of the elements.
Now I'm going to take the percentage of that total
of this total standalone price you can see the bulldozer is 35.7,
the truck, 21.4, the crane, 42.9.
So I'm going to take the percentage of the standalone prices.
Before we went sideways,
we were doing a percentage of
the lease element to the maintenance element and the total contract.
Now, we're going to look based on the standalone prices of the percentage for
each piece of equipment and each maintenance contract based upon the total price.
Now, we're going to take those percentages that we've calculated and we're going to
multiply them times the total rent for each of the segments.
How do we allocate the total cost of this contract between
the lease elements and the non-lease elements such as the maintenance in this case?
Well, in this problem,
we do have the standalone prices.
They're not available from this lessor but they are available
from other providers within the marketplace.
So I know how much it's going to cost to lease a bulldozer without maintenance,
and how much it would cost, therefore,
with maintenance if I bought them separately.
I'm going to sum those and then I'm going to take the percentage of
each of the total price and then I come up with a nice round figure of 80 and 20,
I multiply that times the total payments
within the contract I'm going to allocate $480,000
to the lease element and $120,000 to the non-lease elements, the maintenance.
The next problem we then face is how do we allocate them to the individual pieces of
equipment and to the individual maintenance contracts within the lease.
Well, we're going to do that now by taking a percentage of
each standalone price times this amount that we've allocated into the lease.
Now, I've set that up in the spreadsheet
already and the percentages are for the bulldozer 35.7,
21.4 for the truck,
42.9 for the crane,
and I'm going to use and take this times that standalone price that I've allocated.
I'm going to allocate the lease element and
the non-lease element based on that percentage to
each of these pieces of equipment in each maintenance contract.
When I multiply that times the percentage times the 480,000,
I'm allocating 171,000 to the bulldozer,
102,000 to the truck and 205,000 to the crane,
and the maintenance contract I'm allocating it the same way.
So remember the important differences going to be,
this amount will be on the balance sheet discounted,
as we've already discussed.
This amount will be considered an executory contract.
It will not be on the balance sheet this will continue to be an off balance sheet item.
Let's get back to our work.
So, first thing we did was allocate between the lease
and non-lease elements and we did that by taking the totaling
the standalone prices and multiplying by the ratio of
the total rental payments so we can determine
how much of it's going to be leased and how much of it is non-leased.
Then, we multiplied the ratio of the standalone prices of each lease element to
the total standalone lease element prices by the amount allocated to the lease elements.
We did the same thing for the non-lease elements so we took
the percentage of the lease payment attributable to
each piece of equipment and we did that in
separate use that amount to separate the both the equipment,
and the service in the separate elements.
Now, recall that we did not use
the exact same percentage for the truck lease and non-lease.
The maintenance was different.
It was more expensive perhaps for some of the items such as
a crane rather than a truck and we came up with the separate amounts.
Part of which is going to be considered a
service and will not be in the right of use asset,
and part of it that will be considered a lease
element and will be recorded as a right of use asset in lease obligation.
So the 480,000 allocated to the lease element is
recorded as a lease obligation and related right of use assets.
The 120000 allocated to the non-lease elements is not recorded on the balance sheet.
Non-lease elements are recognized as an expense when incurred.
So this is going to increase the complexity of accounting for a lease,
considerably as operating leases.
Again, the lessee will have the option to include these costs all in a single element.
They won't need to separate them out if they're willing to live with the fact
that they'll have a higher lease obligation and right of use asset.
The lessor does not have that option and is going to have to separate
them out in account for the lease element under
the lease accounting literature ASC 842 and account for
the service elements under the revenue recognition literature ASC 606.
Thank you.
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