Welcome back. In this lesson,
we'll go through a few examples of
multiple elements in the accounting form.
So, remember that nonlease elements within a lease are not
recognized as right-of-use assets and lease obligations.
Those could be services,
it can be maintenance, it can be other goods,
say if you have a printer contract which include the toner,
you wouldn't include the trash for toner in there.
You can see that sometimes with
medical equipment with consumables,
you're not going to include those in the lease payments,
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 there's total consideration in the contract is
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 separately lease elements
and three related maintenance services.
Why is equipment three separate elements?
Well, if the equipment could be used on it's
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 the 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 it's 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 can find
other suppliers that provide equipment and
maintenance services for similar equipment on a standalone basis.
That way there'll 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 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 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 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 element, 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.
In the maintenance contract,
I'm allocating it the same way.
So remember the important difference is 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 me on the balance sheet.
This will continue to be an off-balance sheet item.
So 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 total in
the standalone prices and multiplying by the ratio of
the total rental payments so we can determine
how much of it's going to leased and how much of it is non-lease.
Then we multiply 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 both the equipment
and the service into separate elements.
Now notice, recall that we did not use
the exact same percentage for the truck lease and non-lease.
The maintenance was different,
was more expensive perhaps for some of
the item such as a crane rather than a truck and we
came up with a 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 120,000 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 obligations and right-of-use asset.
The lessor does not have
that option and he's going to have to separate them out in
account for the lease element under
the lease accounting auditor ASC842 and account
for the service elements under
the revenue recognition literature ASC606. Thank you.
John HeppClinical Assistant Professor of Accountancy
