What Are the Requirements for Lease Disclosures?

Lease disclosures provide detailed information about a company’s leasing activities within its financial statements. Accounting Standards Codification (ASC) 842 expanded these requirements to offer transparency to investors, creditors, and other users. This allows them to understand the financial impact of lease obligations and assess the amount, timing, and uncertainty of cash flows arising from leases.

Information Required for Lease Disclosures

The process begins by reviewing all contracts to identify embedded leases. A contract contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. This step requires judgment, as leases can be part of larger service contracts and may not be explicitly labeled. Once a lease is identified, all relevant data must be gathered for calculations and disclosures.

Determining the lease term is a necessary step. The term includes the non-cancelable period of the lease, plus any periods covered by an extension option the lessee is reasonably certain to exercise. It also includes periods covered by a termination option the lessee is reasonably certain not to exercise. This assessment requires considering all economic factors influencing these decisions.

All lease payments must also be identified. These include fixed payments, less any lease incentives, and variable lease payments that depend on an index or a rate. Other payments to be included are amounts probable of being owed by the lessee under residual value guarantees and the exercise price of a purchase option if the lessee is reasonably certain to exercise that option.

The discount rate is used to calculate the present value of the lease payments, which is a component of the lease liability and the right-of-use (ROU) asset. The rate implicit in the lease should be used whenever that rate is readily determinable. If not, the lessee should use its incremental borrowing rate, which is the rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment.

Lessees must classify each lease as either a finance lease or an operating lease. A lease is classified as a finance lease if it meets any one of five criteria indicating the transfer of control of the asset to the lessee. If no criteria are met, it is an operating lease, and this classification determines the subsequent accounting treatment. A lease is a finance lease if:

• The lease transfers ownership of the asset to the lessee by the end of the lease term.
• The lease grants the lessee a purchase option that is reasonably certain to be exercised.
• The lease term is for a major part of the asset’s remaining economic life (75% or more).
• The present value of the lease payments equals or exceeds the asset’s fair value (90% or more).
• The asset is so specialized that it is expected to have no alternative use to the lessor at the end of the lease term.

Lessee Disclosure Requirements

Under ASC 842, lessees must provide both qualitative and quantitative disclosures about their leasing activities. The qualitative, or narrative, disclosures provide context for the numbers in the financial statements, helping users understand the nature of the company’s leases and the associated risks.

Qualitative Disclosures

Qualitative disclosures begin with a general description of the company’s leases, including the nature of the assets being leased, such as real estate, vehicles, or equipment. The disclosure should also describe the basis and terms on which variable lease payments are determined. The company must also disclose information about judgments made in applying the lease standard, such as determining the discount rate and assessing whether it is reasonably certain to exercise an option to extend a lease.

Quantitative Disclosures

Quantitative disclosures provide specific numerical data. Lessees are required to disclose finance lease cost and operating lease cost separately. This includes the amortization of the ROU asset and the interest on the lease liability for finance leases, and the single lease cost for operating leases. The cost associated with short-term leases, those with a term of 12 months or less, must also be disclosed separately.

A maturity analysis of lease liabilities is another required disclosure. This analysis must show the undiscounted cash flows on an annual basis for the first five years and a total amount for the remaining years. The disclosure must also include a reconciliation of the undiscounted cash flows to the lease liabilities recognized on the balance sheet. Lessees must also disclose a weighted-average remaining lease term and a weighted-average discount rate, presented separately for finance and operating leases.

Lessees are also required to provide information about cash flows related to leases. This includes the cash paid for amounts included in the measurement of lease liabilities, segregated between operating and financing cash flows. Supplemental noncash information on lease liabilities arising from obtaining ROU assets must also be disclosed.

Lessor Disclosure Requirements

Lessors also have disclosure requirements under ASC 842 designed to provide insight into their leasing activities and associated risks. Similar to lessees, lessors must provide both qualitative and quantitative information, with specific requirements depending on the type of lease.

Qualitative Disclosures

Qualitative disclosures for lessors include a general description of their leasing arrangements and business model. Lessors must also disclose information about how they manage the risk associated with the residual value of their leased assets. For sales-type and direct financing leases, lessors must provide information about the management of credit risk and residual value risk, along with judgments made in applying the standard.

Quantitative Disclosures

For quantitative disclosures, lessors must provide a breakdown of lease income. For sales-type and direct financing leases, this includes profit or loss recognized at the lease commencement date and interest income. For operating leases, lease income is recognized on a straight-line basis over the lease term. Lessors must also provide a maturity analysis for lease receivables for sales-type and direct financing leases, showing the undiscounted cash flows to be received annually for the first five years and a total for the remaining years.

A reconciliation of the net investment in leases is another required disclosure for sales-type and direct financing leases, showing the changes in the net investment during the reporting period. Lessors must also disclose the components of the net investment in leases, which includes the lease receivable and the unguaranteed residual asset. For operating leases, lessors must disclose lease income and provide a maturity analysis of lease payments.

Disclosures for Special Lease Situations

Certain lease transactions have unique characteristics that require specific disclosures. These situations include sale-leaseback transactions, subleases, and related-party leases. The disclosures for these transactions are intended to provide clarity on the economic substance and financial impact of these arrangements.

Sale-Leaseback Transactions

In a sale-leaseback transaction, an entity sells an asset and then leases it back from the buyer. If the transaction qualifies as a sale under ASC 606, both the seller-lessee and the buyer-lessor have specific disclosure requirements. The seller-lessee must disclose the main terms of the sale-leaseback agreement and any gain or loss arising from the transaction. The buyer-lessor must provide disclosures consistent with its accounting for the purchase of the asset and the subsequent lease.

Subleases

A sublease occurs when a lessee re-leases an asset to a third party. The original lessee, now the intermediate lessor, has specific disclosure requirements. The intermediate lessor must disclose sublease income on a gross basis, separate from the finance or operating lease expense related to the head lease. Qualitative disclosures should also be provided about the nature of the sublease arrangements.

Related-Party Leases

Leases between related parties require special disclosure considerations to ensure transparency. The accounting for related-party leases should be based on the legally enforceable terms and conditions of the lease. Disclosures must be in accordance with ASC 850 and should include the nature of the relationship, a description of the transaction, and the dollar amounts involved.