Accounting For Leases: Leasing and Nonleasing components. FAR CPA Exam

In this video, I discuss the accounting for leasing and nonleasing components as covered on the CPA exam FAR.
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When dealing with a contract that includes both lease (such as the right to use a piece of equipment) and nonlease components (such as maintenance services for that equipment), a lessee has two accounting options:
Option 1: Combine Lease and Nonlease Components
In this approach, each separate lease component is bundled together with its related nonlease components into a single unit of account. This means that the costs and benefits associated with the lease (e.g., the right to use the equipment) and the nonlease elements (e.g., maintenance services) are accounted for as one combined item in the financial statements. This approach simplifies accounting but may reduce the transparency of the separate costs and benefits of the lease and nonlease components.
Option 2: Separate Units of Account for Lease and Nonlease Components
The second option is to keep lease components and nonlease components as separate units of account. This means the costs and benefits related to the lease itself are accounted for independently from those associated with the nonlease components. This approach provides a clearer picture of the financial implications of the lease and nonlease elements of the contract, offering greater detail and transparency in financial reporting.
The choice between these options depends on various factors, including the lessee's accounting policies, the materiality of the nonlease components, and the desire for simplicity versus detail in financial reporting. Each option has implications for the recognition of expenses and liabilities on the balance sheet and income statement, affecting how stakeholders interpret the lessee's financial position and performance.
When a lessee decides how to account for a contract with both lease and nonlease components, the allocation of the contract's total consideration to these components depends on the accounting approach chosen:
If Option 1 is Selected (Combining Lease and Nonlease Components):
In this scenario, where lease and related nonlease components are bundled into a single unit of account, the total contract consideration is allocated to each combined unit based on their relative stand-alone prices. Stand-alone prices are the prices at which the components could be sold separately by the supplier.
If Option 2 is Selected (Separating Lease from Nonlease Components):
When lease components are kept as separate units of account from nonlease components, the total contract consideration is allocated to the separate lease and nonlease components according to their relative stand-alone prices. This approach treats each lease and nonlease component as if it were a distinct contract, providing clarity on the value attributed to each.
In both options, the preference is always to use observable stand-alone prices when available, as these offer the most accurate reflection of each component's market value. However, if observable stand-alone prices aren't available, lessees may use estimated prices. These estimates should be based on reasonable and supportable assumptions and may involve considering the prices of similar components sold separately or other valuation methods.
This allocation method ensures that the financial statements accurately reflect the economic substance of the contract, providing a clear view of the lessee's obligations and expenses associated with both the lease and nonlease components of the contract.
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