eBook-leasing

Real estate leases
Accounting and business considerations
for implementation under ASC 842/IFRS 16
This eBook offers an overview of key issues regarding real estate leases and the
implementation of ASC 842 and IFRS 16 Lease Accounting Standards.
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CONTENT
1. Background 3
Services to be provided
2. Overview: real estate leases 4
Most common forms of real estate leases
i. Net Leases or triple net lease
ii. Modified Gross or Base year leases
iii. Gross Leases
3. Separation of Lease & Non-lease Components 5
iv. Practical Expedient
4. Different accounting treatment for property taxes and insurance 5
v. Variable
vi. Fixed
7. Variable Lease Payments 6
8. Initial Direct Costs 7
9. Sale-Leaseback Accounting 7
Business Impact and Implementation Considerations 8
Summary and Next Steps 9
About Bramasol, Inc 10
Copyright © 2018 Bramasol Inc. www.bramasol.com 2

BACKGROUND
In February 2016, the Financial Accounting Standards
Board (FASB) issued Accounting Standards Update
(ASU) 2016-02 (“ASC 842”), Leases, which provides new
guidelines that change the accounting for leasing
arrangements. The new leasing standard becomes
effective in fiscal years beginning after December 15, 2018,
including interim periods within those fiscal years, for:
››
Public business entities
››
Not-for-profit entities that have issued (or are a conduit
bond obligator for) securities that are traded, listed,
or quoted on an exchange or an over-the-counter
market
››
Employee benefit plans that file financial statements
with the US Securities and Exchange Commission
(SEC)
For all other entities, it becomes effective in fiscal years
beginning after December 15, 2019, and interim periods
in fiscal years beginning after December 15, 2020. Early
adoption is permitted at any time for all entities.
The primary purpose of the standard is to address
the current accounting treatment of operating leases
which are deemed to be off balance sheet financing
arrangements and are only disclosed via a company’s
financial footnotes in the “Commitments and
Contingencies” footnote. Upon the adoption of ASC 842,
Therefore, for every identified lease, companies will be
required to create a lease liability calculated as the present
value of the future fixed payments and a corresponding
asset (“right of use” asset). The right of use asset will be
amortized over the life of the lease. The income statement
will be impacted by a straight-line lease expense item that
would essentially contain an interest component with
the amortization of the asset being the plug-in order to
achieve straight line lease expense over the life of the
lease. One of the key challenges of adopting the new
standard will be for companies to assess and apply the
incremental borrowing rate applicable to them which
will be used in the present value calculations for the
capitalization of lease liability and right of use assets
related to leases.
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Overview: real estate leases
The new leases standard will significantly affect lessees and lessors in the real estate industry, including their
considerations related to non-lease components, initial direct costs, and accounting for sale- leaseback transactions. In
addition, real estate lessors will need to understand the standard’s broader implementation implications for lessees as
well as the potential for changes in tenant behaviors.
Most common forms of real estate leases
The three most common forms of real estate lease are Net Leases, Modified Gross Leases and Gross Leases:
1. Net Leases or triple net lease: A triple net lease (triple-Net or NNN) is a lease agreement on a property where the
tenant or lessee agrees to pay all real estate taxes, building insurance, and maintenance (the three “nets”) on the
property in addition to any normal fees that are expected under the agreement (rent, utilities, etc.). This is where
the tenant pays their share of real estate taxes, insurance, and CAM (“Common Area Maintenance”). Generally,
when the lessee pays the taxes, insurance and CAM fees on behalf of the lessor, these expenses are considered
“variable” and will be excluded from lease payments and expensed as incurred.
2. Modified Gross or Base year leases: This is where the lessee pay their share of increases in real estate taxes, insurance
and CAM over a base year amount. It therefore consists of both fixed and variable portions. The fixed component
will be included in lease payments for real estate taxes and insurance. However, if there is a fixed piece
for CAM this is excluded from lease payments and is expensed as incurred because it is a considered a non-lease
component. The variable piece – i.e., the “excess” amount over base year is excluded from lease payments and also
expensed as incurred.
3. Gross Leases: A gross lease is a type of commercial lease where the lessee pays a flat rental amount, and the
lessor pays for all property charges regularly incurred by the ownership, including taxes, utilities and water. In this
type of lease, the tenants pay a fixed amount which includes all components. In this scenario, the fixed portion
will be included in lease payments for real estate taxes and insurance. As noted before, the fixed piece for CAM is
excluded from lease payment because it is a non-lease component and is expensed as incurred.
Copyright © 2018 Bramasol Inc. www.bramasol.com 4

Separation of Lease & Non-lease Components
Lessees and lessors are required to separate lease components and non-lease components (e.g., any services provided)
in an arrangement and allocate the total transaction price to the individual components. Lessors would perform the
allocation in accordance with the guidance in the new revenue recognition standard, and lessees would do so on a
relative stand-alone-price basis (by using observable stand-alone prices or, if the prices are not observable, estimated
stand-alone prices).
Practical Expedient:
Companies may also elect to not separate lease and
non-lease components by class of underlying assets and
account for each separate lease component along with
the associated non-lease component as a single lease
component (as an accounting policy)
When evaluating whether an activity should be considered
part of a lease component or a separate non- lease
component, an entity should consider whether the
activity transfers a separate good or service to the lessee.
For example, maintenance services (including commonarea
maintenance services) and utilities paid for by the
lessor but consumed by the lessee would be separate
non-lease components because the tenant would have
been required to otherwise contract for these services
separately.
However, payments for property taxes or insurance would
most likely be considered part of the lease component
because they do not transfer a separate good or service
to the tenant. This treatment could have the effect of
increasing a lessee’s lease liability since it would include
amounts that are currently considered executory costs.
From a practical standpoint, however, such amounts are
frequently variable and therefore would not be included in
the measurement of the lease liability.
Different accounting treatment for property taxes and insurance
There are various types of lease agreements involving property taxes and insurance. In some leases, the lessees will pay
a fixed amount of taxes and insurance every year as part of the lease payment. In other lease agreements, the lessor
will send the related tax and insurance bills to the lessee and the lessee will pay it as it is received. Therefore, based
on the two different scenarios, it is possible to have different accounting treatments for property taxes and insurance
depending on the terms of the lease agreement.
Variable:
If the real estate taxes and insurance premiums during the
lease term are variable, these will not be included as part
of the initial measurement of the present value calculation
of the lease liability and instead will be considered a
variable lease payment because the two components are
attributable to the lease of the buildings and no other
service are offered.
Fixed:
If the real estate taxes and insurance premiums during
the lease term are fixed (every year the lessee pays a fixed
amount regardless of the actual amount billed by the
taxing or insurance agency) , these will be included as part
of the as part of the initial measurement of the present
value calculation of the lease liability.
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Variable Lease Payments
In its initial measurement of the lease liability and ROU asset (lessee) or the net investment in the lease (lessor), an entity
would only include variable lease payments if such payments are tied to an index or a rate. However, the entity would
not include variable lease payments that are based on usage or performance of the asset.
A lessee would recognize any variable payments not included in the original lease obligation as an expense in the
period the obligation is incurred. A lessor would recognize variable lease payments not included in the original net
investment in the lease in the period a change occurs in the facts and circumstances on which the variable lease
payments are based (e.g., “when the lessee’s sales on which the amount of the variable payment depends occur”). Even
if a variable lease payment is virtually certain (e.g., contingent upon a retail store’s achievement of a nominal sales
volume), the payment would not be included in the calculation of a lessee’s lease obligation and ROU asset or a lessor’s
net investment in the lease.
Copyright © 2018 Bramasol Inc. www.bramasol.com 6

Initial Direct Costs
Under the new standard, a lessee includes initial direct costs in the initial measurement of the ROU asset. A lessor’s
accounting for initial direct costs is similar to that under current U.S. GAAP. That is, for direct financing leases, a lessor
defers all initial direct costs and includes them in the initial measurement of the lease receivable. Similarly, for operating
leases, a lessor defers the initial direct costs and amortizes them as expenses over the lease term. For sales-type leases,
initial direct costs are expensed up front unless the transaction does not result in a profit or loss.
However, the new standard has changed the definition of initial direct costs to align with the definition of incremental
cost in the new revenue recognition guidance. Initial direct costs for both lessees and lessors now include only those
costs that are incremental to the arrangement and would not have been incurred if the lease had not been obtained.
The change in the definition of initial direct costs will affect many real estate entities. Costs such as commissions
(whether paid to employees or third-party brokers) and payments made to existing tenants to obtain the lease will
continue to be considered initial direct costs. By contrast, costs such as allocated internal costs and costs to negotiate
and arrange the lease agreement (e.g., professional fees such as those paid for legal and tax advice) are excluded from
this definition. This is likely to result in changes in practice for many real estate lessors, which currently capitalize such
costs.
Sale-Leaseback Accounting
The FASB also aligned sale-leaseback accounting with the underlying principles in the new revenue recognition
standard. Under the new leases guidance, the seller-lessee in a sale-leaseback transaction must evaluate the transfer of
the underlying asset (sale) in accordance with ASC 606 to determine whether the transfer qualifies as a sale (i.e., whether
control has been transferred to the buyer). The existence of a leaseback by itself would not indicate that control has not
been transferred (i.e., it would not preclude the transaction from qualifying as a sale) unless the leaseback is classified
as a finance lease. In addition, if the arrangement includes an option for the seller-lessee to repurchase the asset, the
transaction would not qualify as a sale unless (1) the option is priced at the fair value of the asset on the date of exercise
and (2) alternative assets exist that are substantially the same as the transferred asset and are readily available in the
marketplace. If the transaction does not qualify as a sale, the seller- lessee and buyer-lessor would account for it as a
financing arrangement (i.e., the buyer-lessor would account for its payment as a financial asset and the seller-lessee
would record a financial liability).
Sale-leaseback transactions involving real estate that include a purchase option are not expected to meet the criteria
to qualify as a sale, regardless of whether the purchase option is at fair value. Each real estate property is unique and
not readily available in the marketplace because of various factors such as location and specified use; therefore, the
existence of a purchase option on the real estate, whether it is at fair value or not, is evidence that the real estate is not
readily available in the marketplace.
Accordingly, in a manner similar to current U.S. GAAP, any purchase options on real estate will preclude sale-leaseback
accounting for the seller-lessee.
The new standard will also affect the evaluation of sale-leaseback transactions by the buyer-lessor. Under current U.S.
GAAP, the buyer-lessor accounts for its purchase and subsequent lease without regard to the seller-lessee’s accounting
for the transaction. Under the ASU, the buyer-lessor’s and seller- lessee’s accounting must be symmetrical. Accordingly,
the buyer-lessor must assess whether the seller- lessee has achieved a sale under ASC 606 before it can determine its
accounting for the purchase of the real estate assets.
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Business Impact and Implementation Considerations
The new lease accounting requirements could change how real estate entities do business and could affect tenant
behaviors. For example:
1. Since the adoption of ASC 842/IFRS 16 will result in increased leverage on the balance sheet, lessees may want to
negotiate shorter-term leases or leases that include more variable lease payments. Such negotiations could result in
increased operating costs for both lessees and lessors.
2. An increase in shorter-term leases could also result in higher rental rates and, therefore, additional operating costs.
This could also affect (i) the lessor’s ability to obtain financing, (ii) the financing costs on the property, (iii) and the
fair value of the lessor’s property.
3. Because most leases will be on the lessees’ balance sheets, lessees may be more motivated to consider whether to
lease or purchase a property, particularly those that currently enter into long-term, triple-net leases.
4. Bringing leases onto the balance sheet will result in increased leverage and affects an entity’s key metrics. Real estate
entities that are also lessees under lease agreements (e.g., a land lease for one of the real estate entity’s properties)
should consider whether the increased leverage could result in debt covenant violations or potentially affect
lending decisions.
5. The new guidance may complicate a lessee’s internal approval of new leases or lease modifications since different
individuals may need to closely consider the effects on the financial statements. Under current U.S. GAAP, a lessee’s
decision to enter into an operating lease may not necessarily receive much opposition or challenge from management.
However, operating leases potentially will now be scrutinized as much as out-right purchases because of
their effect on the balance sheet. In addition, in its decisions related to leases, an entity may need to involve personnel
from a number of departments, such as accounting, corporate reporting, treasury, IT, legal and procurement.
Copyright © 2018 Bramasol Inc. www.bramasol.com 8

Summary and Next Steps
With only a few months remaining to get ready for compliance with ASC 842 and IFRS 16, companies need to start their
implementation projects as soon as possible. As a co-innovation partner with SAP and a leader in delivering purposebuilt
compliance solutions, Bramasol has worked closely on the development and deployment of lease accounting
compliance capabilities.
For companies that need to manage real estate assets as well as moveable assets such as equipment, we recommend
SAP Contract and Lease Management, which is tightly integrated with existing SAP platforms and can also interface to
other legacy ERP and financial systems.
Enables compliance with
IFRS 16 and ASC 842 lease
accounting standards
Capabilities for handling
both real estate and
moveable assets
Comprehensive
management of lease
portfolio during transition
to the new standards
Key benefits of SAP Contract and Lease Management
Disclosure Reporting
with required
accounting lookback
and statutory reporting
Native integration, rapid
implementation time and
reduced TCO
Future-proof support
for SAP roadmap
platform evolution
(e.g. S/4HANA and
beyond)
Undertaking a proactive implementation program now will not only improve company-wide lease management
capabilities of all asset classes. It will also establish a solid foundation of process discipline, lease accounting and
auditable lease assets to prepare you for compliance with the changes to lease accounting standards coming in 2019.
The resultant improvements in contract and asset management will also deliver ongoing benefits in the areas of
productivity, agile reporting, audit readiness and Financial Transformation over the longer term.
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About Bramasol, Inc.
Bramasol is the leader in SAP Leasing, Revenue Recognition and Office of the CFO Solutions
Bramasol is the Leasing leader and a recognized SAP Leasing services partner for companies seeking to comply
with and benefit from the new Leasing standards. Our SAP-certified experts, partnering with SAP and Nakisa, have
lead the way in education and enablement of the new Leasing standards. Even before the announcement of the
new IFRS 16 and ASC 842 standards, Bramasol was working to educate companies on the coming changes and
how to leverage the existing Revenue Recognition work to help with compliance. Our industry leading experience
and focus on Office of the CFO solutions, enables our customers to ramp up quickly and evaluate the options to
not only comply with the standards, but transform finance during the process.
Bramasol is also the Revenue Recognition leader and a recognized SAP Revenue Recognition services partner
for companies seeking to comply with and benefit from the new Rev Rec standards. Our SAP- certified experts,
partnering with SAP, assisted in the majority of SAP Revenue Accounting and Reporting Ramp-Up projects. Driving
successful workshops, Proofs of Concept, and implementation projects throughout the U.S., Bramasol is the goto
partner with the experience and expertise for companies wanting to leverage SAP Revenue Accounting and
Reporting to comply with ASC-606 and IFRS 15.
Currently, Bramasol is performing implementations and Proofs of Concept/Pilots for additional clients; proving
that Bramasol is a go-to partner with experience and expertise for companies wanting to utilize SAP Revenue
Accounting and Reporting to be compliant with the Financial Accounting Standards Board (FASB) current US
Generally Accepted Accounting Principles (GAAP) revenue recognition standard or the newly announced ASC-
606 and International Financial Reporting Standards (IFRS) 15 addressing the “Revenue From Contracts with
Customers”.
Whether you are looking for a SaaS, hosted or on-premise solution, Bramasol has worked with over 150 clients to
solve business challenges using SAP solutions including SAP Business Suite, SAP Business All-in- One, SAP Business
Intelligence solutions, SAP Business ByDesign®, the SAP HANA® platform and mobile solutions. If you are looking to
build a platform for growth or just be “Rev Rec Ready”, contact us and we can help.
Contact Information:
United States – Headquarters
Bramasol, Inc.
3979 Freedom Circle, Suite 620 Santa Clara, CA 95054
Toll Free (866) 625-9878
Phone +1 (408) 831-0046
Fax (408) 831-0047
info@bramasol.com