6.1 Asset disposals overview

Publication date: 31 Jul 2020

A long-lived asset should be derecognized when it is disposed. There are various ways that a reporting entity can dispose or partially dispose of a long-lived asset. Prior to disposing of a long-lived asset a reporting entity should determine whether the disposal group meets the held for sale criteria. For further details regarding a disposal group and the held for sale criteria, refer to PPE 5.3. This chapter discusses various aspects of accounting for disposals by sale (see PPE 6.2) and disposals other than by sale (see PPE 6.4).

The derecognition of nonfinancial assets and in substance nonfinancial assets for transactions with non-customers is codified in ASC 610-20. The objectives of ASC 610-20 are to (1) generally align the accounting for transfers of nonfinancial assets to non-customers with the accounting for contracts with customers under ASC 606 and (2) provide specific guidance for transfers of certain nonfinancial assets (such as equipment or intangible assets). Additionally, ASC 610-20 eliminates rules specifically addressing sales of real estate (i.e., ASC 360-20). ASC 610-20 was effective at the same time a reporting entity adopted the amended revenue guidance in ASC 606. Transition guidance for ASC 610-20 is covered in PPE 6.3.

In addition to accounting for the disposal of nonfinancial assets, a reporting entity may have related activities applicable to the guidance under ASC 420-10, Exit or Disposal Cost Obligations. This guidance addresses the recognition, measurement, and reporting of costs associated with exit and disposal activities, including restructuring activities. ASC 420-10 focuses on the recognition of liabilities, specifically requiring that companies only record such liabilities when they are incurred. This guidance is discussed further in PPE 6.5.

6.2 Disposals by sale

Publication date: 31 Jul 2020

Long-lived assets are often disposed of by a sale to a third party (e.g., sale of a plant by a manufacturing company). Each transaction should be evaluated to determine the appropriate derecognition guidance to apply in accounting for the disposal.

A reporting entity should first determine whether the transaction is partially in the scope of other topics. For example, a guarantee created in conjunction with the transfer of a nonfinancial asset, or a seller's obligation to provide a separate identifiable service to the buyer will likely be accounted for separate from the disposal. See PPE 6.2.1 for further discussion on transactions that are partially in the scope of other topics.

The reporting entity will need to determine whether the transaction is in the scope of ASC 610-20, Gains and Losses from the Derecognition of Nonfinancial Assets, or other topics. For example, the sale of assets in the ordinary course of business (e.g., sale of a car by a car dealer) are governed by the revenue guidance in ASC 606, Revenue from Contracts with Customers. Furthermore, the sale of a group of long-lived assets that constitutes a business and that is not a sale to a customer should be accounted for in accordance with ASC 810-10-40, unless it is a conveyance of oil and gas mineral rights (see ASC 932-360, Extractive Activities – Oil and Gas, Property, Plant, and Equipment). As discussed in PPE 6.2.2.5, financial assets (e.g., equity method investments) that are disposed in conjunction with the sale of nonfinancial assets may also be within the scope of ASC 610-20 when they are determined to be in substance nonfinancial assets. Refer to PPE 6.2.2 for further details on evaluating the appropriate derecognition model for various disposals.

Once it is determined that the disposal is within the scope of ASC 610-20, the entity will need to allocate the contract consideration (see PPE 6.2.3), determine whether the disposal meets the derecognition criteria (see PPE 6.2.4), and measure the gain or loss upon derecognition (see PPE 6.2.5).

Figure PPE 6-1 provides an overview of the steps to consider when applying the guidance in ASC 610-20.

Figure PPE 6-1
Steps to consider in applying the guidance in ASC 610-20

Figure PPE 6-1

 

6.2 Disposals by sale - 6.2.1 Assessing what is part of a disposal

Publication date: 31 Jul 2020

The seller may have certain arrangements that should be accounted for separately from the disposal transaction. In many disposal transactions, a seller may make certain representations and warranties associated with the sale. See PPE 6.2.1.1 for further considerations when accounting for these arrangements.

The seller and buyer may have a preexisting relationship before negotiations for the sale of long-lived assets or they may enter into an arrangement during the sale negotiations that are separate from the sale of long-lived assets. For example, a buyer might pay a lump-sum amount to a seller in exchange for a warehouse and the seller's commitment to provide maintenance services for the 12-month period after the sale. A question arises as to whether a portion of the lump-sum payment should be allocated to the maintenance services.

If the arrangements include the seller's obligation to provide a separate identifiable service to the buyer or settle a preexisting relationship between the seller and buyer, the seller should evaluate whether each of the arrangements are entered into on an arm's length basis. This may impact the measurement of the gain or loss on the sale of the long-lived assets and the accounting for the subsequent service arrangement or settlement of the preexisting relationship. There is no explicit guidance for determining what is part of a disposal under US GAAP. In making this determination, among other things, the seller should consider the reasons for the transaction, who initiated the transaction, and the timing of the transaction, by analogy to the guidance for an acquisition in ASC 805-10-55-18. The assessment is a matter of judgment and should be based on the individual facts and circumstances.

Example PPE 6-1 further demonstrates the accounting for a transition services agreement.

EXAMPLE PPE 6-1
Accounting for a transition services agreement when the seller of a plant will perform services at no cost to the buyer

Manufacturing Co agrees to sell a manufacturing plant for $100 million to PPE Corp. Manufacturing Co's net book value of the assets sold to PPE Corp is $70 million, with a fair value of $95 million. In connection with the purchase and sale agreement, Manufacturing Co and PPE Corp also enter into a transition services agreement (TSA) under which Manufacturing Co agrees to provide building management services to PPE Corp for a period of one year at no cost to PPE Corp. Manufacturing Co estimates the fair value of the services to be provided under the TSA to be $5 million, at a cost of $3 million. For simplicity, all tax effects have been ignored, and assume that there are no direct costs to sell the manufacturing plant.

How should Manufacturing Co determine the gain to be recognized upon sale of the plant to PPE Corp?

Analysis

On the date of sale, Manufacturing Co should allocate a portion of the proceeds to the fair value of the services to be rendered under the TSA. Although the TSA agreement stipulates that the services will be performed by Manufacturing Co at no cost to PPE Corp, the substance of the transaction is that a portion of the consideration for the sale of the plant relates to the transition services that will be provided in the future. Manufacturing Co should recognize the $5 million (i.e., the estimated fair value of the services to be provided under the TSA) over the period during which the services are rendered. Expenses related to the TSA should be recognized as incurred. On the date of the sale, Manufacturing Co should recognize a gain on disposal of the plant of $25 million ($100 million sales price - $5 million allocated to the TSA - $70 million net book value).

Manufacturing Co should report the proceeds received from providing the service under the TSA as "other income," assuming such services do not relate to the primary business in which Manufacturing Co operates. Expenses should be reported in their natural expense classifications.

6.2 Disposals by sale - 6.2.1 Assessing what is part of a disposal - 6.2.1.1 Seller representations

Publication date: 31 Jul 2020

In many disposal transactions, a seller may make general representations and warranties associated with the sale. In addition, the seller may agree to indemnify the buyer for events that occurred prior to the sale (e.g., environmental or litigation exposure). When a sales agreement includes a provision that may cause the seller to not receive all of the stated sales proceeds (or to return some or all of the initial sales consideration), consideration should be given to the amount and timing of recognition of the gain or loss on sale.

Absent evidence to the contrary, general representations and warranties provided by the seller as a part of the sale are usually valid as of the sale date. A future claim by the buyer is usually not expected and therefore would not affect the gain or loss recognized on the date of sale.

If the representations and warranties are indemnifications that fall under the guidance of ASC 460-10-15-4(c) (within the "Guarantees" subtopic), a liability should be recorded at the sale date by the seller (i.e., the seller should recognize the potential for a future cash outflow resulting from the indemnifications). The nature of the indemnifications determines whether they would be within the scope of ASC 460-10. ASC 460-10-15-4(c) refers to indemnification agreements that "contingently require the indemnifying party (guarantor) to make payments to an indemnified party (guaranteed party) based on changes in an underlying that is related to an asset, a liability, or an equity security of the indemnified party." In applying this guidance, a general representation and warranty as to the authorized capital stock of an acquired entity, a common item included in acquisition agreements, would not represent an indemnification within the scope of ASC 460-10 as it is not related to a change in an underlying asset, liability, or equity security. On the other hand, if the seller offered an indemnification limiting a buyer's economic exposure to a specific foreign tax position related to an entity being sold, it would most likely be appropriate to recognize a liability for the fair value of the guarantee following the guidance in ASC 460-10 (see TX 15.8 for further guidance on tax-related indemnifications).

If the guarantee was created in conjunction with the contemporaneous transfer of a nonfinancial asset, it would represent a distinct element outside the scope of ASC 610-20. Accordingly, a reporting entity would reduce the transaction price of the nonfinancial asset by the fair value of the guarantee liability. The residual transaction price would be allocated to the remaining elements, as discussed in PPE 6.2.3. This is further explored in Example PPE 6-2.

EXAMPLE PPE 6-2
Calculating the gain or loss on the sale of a long-lived asset when the seller provides an indemnification

Seller Corp sells a machine with a carrying value of $5,000 to Buyer Corp for $8,000. The sales price can be reduced by up to $1,000 based on Buyer Corp's verification of Seller Corp's representation of the machine's tax basis. Seller Corp concludes that the tax indemnification is within the scope of ASC 460. In accordance with ASC 460-10, Seller Corp recognizes a liability for the fair value of the tax indemnification at the date of the sale, which is estimated to be $500.

How should Seller Corp determine the gain to be recognized upon sale of the machine?

Analysis

Seller Corp would record a $2,500 gain in the period of the disposal of the machine, which is equal to the sales price less the carrying value less the fair value of the indemnification ($8,000-$5,000-$500).

Indemnifications, guarantees, and warranties not within the scope of ASC 460-10 should be evaluated to determine if such amounts represent variable consideration. If such amounts are determined to be variable consideration, the seller should evaluate whether the amounts to be received from the buyer at a future date, would be constrained. See PPE 6.2.5.1 for further details.

In some disposal transactions, part of the consideration for the sale of an asset is held in an escrow account and released to the seller at a later date, usually upon the passage of time or upon the satisfaction of certain considerations. Proceeds held in escrow may represent variable consideration (i.e., based on future events occurring or conditions being met) or collateralize the seller's representations and warranties associated with the sale. When an escrow arrangement is established, the seller should consider the accounting implication of the arrangement. Assuming the proceeds in escrow are not included on the seller's balance sheet, it may be appropriate to recognize a receivable for part or all of the proceeds held in an escrow account at the time of sale and to include such amounts as part of the consideration received for the sale of the asset when determining the gain or loss on sale. Recognition of amounts in escrow is further explored in Example PPE 6-3.

EXAMPLE PPE 6-3
Recognition of amounts in escrow

Seller Corp sold one of its manufacturing facilities, Plant A, to Buyer Corp for $10 million in cash, of which $1 million was placed in an escrow account. The $1 million set aside is to be used to compensate Buyer Corp for any violations of the general representations and warranties listed in the purchase agreement. Seller Corp is not aware of any potential claims and has assessed the probability of having incurred a violation to be insignificant. Barring any violations, the cash in the escrow account will be released to Seller Corp one year after the sale. Management has determined that the $1 million in the escrow account does not represent contingent consideration.

How should the $1 million in the escrow account be recognized by Seller Corp?

Analysis

As management of Seller Corp has determined its representations and warranties do not represent indemnifications within the scope of ASC 460-10, and the probability that a violation will occur is insignificant, the entire sales price of $10 million, which includes the $1 million held in escrow, should be recorded at the closing date and considered in determining the gain or loss on sale of Plant A.

6.2 Disposals by sale - 6.2.2 Determining the derecognition model for the disposal

Publication date: 31 Jul 2020

After determining whether the contract is partially in the scope of other topics and determining what is part of the disposal transaction, each disposal should be evaluated to determine the appropriate derecognition guidance to apply in accounting for the transaction. Figure PPE 6-2 provides a decision tree for evaluating the applicable derecognition model for various nonfinancial asset disposals and references where further details can be found.

Figure PPE 6-2
Determining assets that are in the scope of ASC 610-20 for derecognition

Figure 6-2

6.2 Disposals by sale - 6.2.2 Determining the derecognition model for the disposal - 6.2.2.1 Determining whether a sale is to a customer

Publication date: 31 Jul 2020

Per ASC 610-20-15-4(a), if the counterparty in the transaction is a customer and the assets being transferred are an output of the reporting entity's ordinary activities, the transaction is within the scope of ASC 606. This may include intellectual property licensing transactions. As stated in ASC 606, a customer is a party that has contracted with an entity to obtain goods or services that are an output of the reporting entity's ordinary activities in exchange for consideration (e.g., a car manufacturer sells a car that it produced to a customer, a homebuilder sells a home that it developed to a customer). Transactions with customers are addressed in PwC's guide, Revenue from contracts with customers. Refer to RR 2.4 for further guidance on identifying the customer in a contract.

The sale of a nonfinancial asset that is not an output of the reporting entity's ordinary activities would be accounted for under ASC 610-20 because the counterparty does not meet the definition of a customer for that specific transaction. For example, when a telecommunications company sells its phone service to a customer, the phone service is considered to be an output of that company's ordinary activity. However, if the same company sells that counterparty trucks that it no longer needs to maintain its equipment, the trucks are not an output of the company's ordinary activity and are not considered to be a sale to a customer.

A counterparty to the contract would not be a customer if the counterparty has contracted with the entity to participate in an activity or process in which the parties to the contract share in the risks and benefits that result from the activity or process (such as developing an asset in a collaboration arrangement) rather than to obtain the output of the reporting entity's ordinary activities.

Determining whether the counterparty to a disposal arrangement is a customer is important as revenue from contracts with customers will follow the guidance in ASC 606. While ASC 610-20 includes certain recognition and measurement principles of ASC 606, there are different presentation and disclosure requirements. For example, transactions with customers will be reported in revenue and cost of goods sold under ASC 606 while transactions with non-customers will usually be presented as a gain or loss included in income from continuing operations before income taxes under ASC 610-20 (per the guidance in ASC 610-20-45-1, which refers to the guidance in ASC 360-10-45-5 for presentation of the gain or loss on sale).

This determination could also impact the elimination of intercompany profits and losses for transfers of nonfinancial assets between an investor and an equity method investee. The guidance in ASC 323-10-35-7 provides an exception which excludes arm's-length transactions when an investor sells a nonfinancial asset that is in the scope of ASC 610-20 to an equity method investee. Under the exception, when an equity method investee records a gain or loss on sale of a nonfinancial asset that is within the scope of ASC 610-20, the investor is not required to eliminate the intercompany gain or loss on sale from this transaction. See CG 4.5.2 for further details regarding the elimination of intercompany transactions for investments accounted for under the equity method.

6.2 Disposals by sale - 6.2.2 Determining the derecognition model for the disposal - 6.2.2.2 Sale of a business

Publication date: 31 Jul 2020

Per ASC 610-20-15-4(b), if the transferred set meets the definition of a business under ASC 805 and is not a sale to a customer, the transaction is within the scope of the derecognition guidance in ASC 810, regardless of whether a legal entity is transferred. For additional guidance on the definition of a business, see BCG 1.2.

ASC 810-10-40 requires the reporting entity to deconsolidate a subsidiary or derecognize a group of long-lived assets as of the date the reporting entity ceases to have a controlling financial interest. Full gain or loss is recognized in net income in the period of deconsolidation or derecognition. See BCG 5.5 for further details regarding the sale of businesses.

6.2 Disposals by sale - 6.2.2 Determining the derecognition model for the disposal - 6.2.2.3 Financial assets under ASC 860

Publication date: 31 Jul 2020

Per ASC 610-20-15-4(e), if the transaction is entirely within the scope of ASC 860, then apply ASC 860 (e.g., the only asset transferred in the transaction is a financial asset). When a sale includes both financial and nonfinancial assets, the financial assets will be within the scope of ASC 610-20 if they are determined to be in substance nonfinancial assets. See PPE 6.2.2.5 for details regarding which financial assets are determined to be in substance nonfinancial assets.

Financial assets under the scope of ASC 860 include the transfer of investments accounted for under ASC 323, Investments - Equity Method and Joint Ventures. Regardless of whether the sale is of an entire position or a partial sale of an equity method investment, entities should apply the guidance contained in ASC 860 to assess such transfers. Under ASC 610-20, entities will no longer "look through" these investments to determine if the underlying assets should be accounted for under other guidance, as was previously required under the real estate-specific guidance. For example, if a reporting entity only sells its interest in an equity method investment (i.e., the company does not sell the interest in conjunction with other assets or liabilities), the transaction would be entirely within the scope of ASC 860, even if the only assets held by the equity method investee are nonfinancial assets.

See CG 4.7.6 and TS 1.3 for further discussion on the accounting for transfers of financial assets.

6.2 Disposals by sale - 6.2.2 Determining the derecognition model for the disposal - 6.2.2.4 Other scope exceptions

Publication date: 31 Jul 2020

In addition to the scope exceptions for a sale to a customer, sale of a business, and transfer of financial assets, there are other scope exceptions in ASC 610-20-15-4, these exceptions include:

  • Sale and leaseback transactions within the scope of ASC 842-40 (or prior to adoption of ASC 842, a real estate sale-leaseback transaction or a non-real estate sale-leaseback transaction within the scope of ASC 360-20 or ASC 840-40, respectively). See LG 6 for more information on accounting for sale and leaseback transactions.

  • Conveyances of oil and gas mineral rights within the scope of ASC 932-360

  • Transfers of nonfinancial assets that are part of the consideration in a business combination within the scope of ASC 805, which should be recorded following ASC 805-30-30-8. See BCG for details on accounting for business combinations.

  • Nonmonetary exchanges within the scope of ASC 845. See PPE 2.3.1.1 for details on accounting for nonmonetary exchanges in an asset acquisition.

  • Lease contracts within the scope of ASC 842 (or ASC 840 prior to the adoption of ASU 2016-02, Leases). See LG for details on accounting for leases.

  • Transfers of nonfinancial or in substance nonfinancial assets solely between entities under common control. See BCG 7 for more information on the accounting for common control transactions.

  • An exchange of takeoff and landing slots within ASC 908-350

  • A contribution of cash and other assets, including a promise to give, within the scope of ASC 720-25, Other expenses - Contributions made, or ASC 958-605, Not-for-profit entities – Revenue recognition.

  • Transfer of an investment in a venture accounted for by proportionate consolidation, as described in ASC 810-10-45-14

6.2 Disposals by sale - 6.2.2 Determining the derecognition model for the disposal - 6.2.2.5 Nonfinancial assets and in substance nonfinancial assets

Publication date: 31 Jul 2020

If one of the scope exceptions in ASC 610-20 does not apply, the reporting entity will need to determine whether the assets transferred are nonfinancial assets or in substance nonfinancial assets, which are in the scope of ASC 610-20. Some examples of nonfinancial assets include intangible assets, long lived assets (e.g., land, building, machinery, equipment), materials, and supplies.

In substance nonfinancial assets are defined in ASC 610-20-15-5.

Excerpt from ASC 610-20-15-5

An in substance nonfinancial asset is a financial asset (for example, a receivable) promised to a counterparty in a contract if substantially all of the fair value of the assets (recognized and unrecognized) that are promised to the counterparty in the contract is concentrated in nonfinancial assets.

If substantially all of the fair value of the assets that are promised in a contract is concentrated in nonfinancial assets, the financial assets promised to the counterparty are considered to be in substance nonfinancial assets and are in the scope of ASC 610-20. For example, if a reporting entity transfers a building and receivables that together do not comprise a business to a non-customer and substantially all of the fair value is concentrated in the building (i.e., a nonfinancial asset), the receivables would be considered in substance nonfinancial assets. Consequently, both the building and the receivables would follow the derecognition guidance in ASC 610-20 (i.e., the receivables are not in the scope of ASC 860 for derecognition).

ASC 610-20 does not define what constitutes "substantially all." However, the term is used in other areas of GAAP (e.g., definition of a business, leases) and, while not a bright line, is typically interpreted to mean approximately 90% or greater.

Cash, cash equivalents, deferred taxes, and liabilities are excluded from the determination of whether substantially all of the fair value of the assets transferred is concentrated in nonfinancial assets. Cash transferred with the assets should be considered a reduction of the transaction price, consistent with ASC 606 for consideration payable to a customer. See RR 4.6 for details.

If a transaction includes the transfer of multiple assets that are transferred either as a direct ownership interest in the individual assets or transferred through an ownership interest in one or more consolidated subsidiaries, the transaction should be assessed in the aggregate to determine if it is in the scope of ASC 610-20. When a reporting entity transfers an ownership interest in one or more consolidated subsidiaries (that is not a business), it must look to the underlying assets of the subsidiaries for this determination. If the assets transferred in the transaction are comprised of substantially all nonfinancial assets, the transaction is accounted for under ASC 610-20. Otherwise, each individual asset and each individual subsidiary will be evaluated separately to determine whether they are within the scope of ASC 610-20.  

When a transferred subsidiary is not in the scope of ASC 610-20 (e.g., the transaction in the aggregate is not comprised of substantially all nonfinancial assets and when assessed individually the subsidiary is not comprised of substantially all nonfinancial assets), the entire subsidiary would be derecognized using the guidance in ASC 810-10-40-3A(c) or ASC 810-10-45-21A(b)(2), unless other guidance addresses the substance of the transaction (e.g., ASC 805, ASC 606, ASC 845, ASC 860, ASC 932). When derecognizing the subsidiary, the reporting entity should not separate the individual assets transferred; rather, the entire subsidiary should be derecognized under the same derecognition model.

When an ownership interest in an unconsolidated entity (e.g., equity method investments, investments in joint ventures) is transferred, the investor does not need to evaluate the underlying assets of the investee. The ownership interest of an equity investee is a financial asset.

Example PPE 6-4, Example PPE 6-5, and Example PPE 6-6 illustrate the evaluation of financial assets and nonfinancial assets sold in a single transaction that, when combined, are not a business or sale to a customer. Figure PPE 6-2 is a decision tree which includes an overview of the evaluation of nonfinancial assets and in substance nonfinancial assets, including those held in consolidated subsidiaries.

EXAMPLE PPE 6-4
Transfer of subsidiaries – Substantially all of the fair value is concentrated in nonfinancial assets

Seller Corp transfers ownership interests in Subsidiaries A and B to Buyer Corp, a non-customer. Individually and when combined, Subsidiaries A and B are not businesses and contain the following types of assets at fair value, excluding cash.

 

Financial

 

Nonfinancial

 

Percent nonfinancial

Subsidiary A

$5

$95

95%

Subsidiary B

3

 

7

 

70%

 

$8

 

$102

 

93%

Should Seller Corp derecognize Subsidiary A and Subsidiary B using the guidance in ASC 610?

Analysis

Yes. Given that substantially all of the fair value of the underlying assets on an aggregate basis is concentrated in nonfinancial assets (i.e., 93% nonfinancial assets), all of the financial assets are considered in substance nonfinancial assets. Consequently, the assets in Subsidiary A and Subsidiary B would be derecognized by Seller Corp using the guidance in ASC 610-20.

EXAMPLE PPE 6-5
Transfer of subsidiaries - Substantially all of the fair value is not concentrated in nonfinancial assets

Seller Corp transfers ownership interests in Subsidiaries C and D to Buyer Corp, a non-customer. Individually and when combined Subsidiaries C and D are not businesses and contain the following types of assets at fair value, excluding cash.

 

Financial

 

Nonfinancial

 

Percent nonfinancial

Subsidiary C

$5

$95

95%

Subsidiary D

30

 

70

 

70%

 

$35

 

$165

 

83%

Should Seller Corp derecognize Subsidiary C and Subsidiary D using the guidance in ASC 610?

Analysis

On an aggregate basis, substantially all of the fair value of the underlying assets is not concentrated in nonfinancial assets (i.e., 83% nonfinancial assets). Therefore, each of the entities would be evaluated separately. The assets in Subsidiary C would be derecognized under ASC 610-20 because substantially all of the fair value of the underlying assets in that subsidiary is concentrated in nonfinancial assets (i.e., 95% nonfinancial assets). However, the guidance in ASC 810 would be applied to the transfer of Subsidiary D.

EXAMPLE PPE 6-6
Transfer of subsidiaries and other individual assets - Substantially all of the fair value is not concentrated in nonfinancial assets

Seller Corp transfers ownership interests in Subsidiaries C and D to Buyer Corp, a non-customer. Additionally, in conjunction with the transfer, Seller Corp transfers ownership interests in other individual assets, which include its interest in an equity method investment and its interest in a long-lived asset (equipment). Individually and when combined the individual assets, Subsidiary C and Subsidiary D are not businesses and contain the following types of assets at fair value, excluding cash.

Financial

Nonfinancial

Percent nonfinancial

Individual assets

$8

$92

92%

Subsidiary C

5

 

95

 

95%

Subsidiary D

30 

 

70

 

70%

 

$43

 

$257 

 

86%

Should Seller Corp derecognize the individual assets, Subsidiary C, and Subsidiary D using the guidance in ASC 610?

Analysis

On an aggregate basis, substantially all of the fair value of the underlying assets is not concentrated in nonfinancial assets (i.e., 86% nonfinancial assets). Therefore, each distinct asset and each individual subsidiary would be evaluated separately. The equity method investment is a financial asset and will be derecognized under ASC 860. The long-lived asset is a nonfinancial asset and will be derecognized under ASC 610-20. The assets in Subsidiary C would be derecognized under ASC 610-20 because substantially all of the fair value of the underlying assets in that subsidiary is concentrated in nonfinancial assets (i.e., 95% nonfinancial assets). However, the other relevant guidance in ASC 810 would apply to the transfer of Subsidiary D.

6.2 Disposals by sale - 6.2.2 Determining the derecognition model for the disposal - 6.2.2.6 Examples of typical disposal transactions

Publication date: 31 Jul 2020

Figure PPE 6-3 summarizes the main categories of disposal transactions and where such disposals are further discussed, either in this chapter or in other PwC guides.

Figure PPE 6-3
Key types of disposal transactions

Type of transactions

Accounting literature

Reference for more information

Sale to a customer (ASC 606)

 

 

Sale of nonfinancial assets* to a customer

ASC 606

RR 1

Sale of a business (ASC 810)

 

 

Sale of nonfinancial assets* that meet the definition of a business to a noncustomer

ASC 810-10

PPE 6.2
BCG 5.5
BCG 2.6.5.4

Sale of a nonfinancial asset that is not a business to a noncustomer (ASC 610-20)

 

 

Sale of nonfinancial assets*

ASC 610-20

PPE 6.2

Sale of a legal entity that owns substantially all nonfinancial assets* or that is otherwise in the scope of ASC 610-20

ASC 610-20

PPE 6.2
PPE 6.2.2

Distribution of nonfinancial* assets to owners in a split-off transaction

ASC 610-20

PPE 6.4.3

Exchange of principally nonfinancial assets*

ASC 610-20

PPE 6.4.5

Contribution of nonfinancial assets* to an investee or to an investor in an equity method investment

ASC 610-20

PPE 6.2
CG 4.4.1.1
CG 4.4.1.3

Contribution of nonfinancial assets* to an investee or to an investor in an equity security

ASC 610-20

PPE 6.2
LI 2

Contribution of nonfinancial assets* to a joint venture or to an investor in a joint venture

ASC 610-20

PPE 6.2
CG 5.3.1.2

Sale of financial assets (ASC 860)

 

 

Sale of an undivided interest accounted for using the equity method

ASC 860

CG 4.7
TS 1.2.1

Sale of all or a portion of an equity method investment**

ASC 860

CG 4.7
TS 1.2.1

Other transactions

 

 

Sale of an undivided interest accounted for using the proportionate consolidation method

ASC 810

CG 6.4

Sale of a legal entity that does not own substantially all nonfinancial assets* and that is not otherwise in the scope of ASC 610-20

ASC 810

PPE 6.2
PPE 6.2.2

Receipt of funds in research and development arrangements

ASC 730-20

PPE 8.3.4

Abandonment of nonfinancial assets

ASC 360-10

PPE 6.4.1

Distribution of nonfinancial assets that constitute a business to owners in a spinoff transaction

ASC 505-60 / ASC 845-10

PPE 6.4.2

Involuntary conversion of nonfinancial assets

ASC 610-30

PPE 6.4.3

Transfer of nonfinancial assets to entities under common control

ASC 805-50

BCG 7

* This includes real estate. ASC 610-20 eliminated specific guidance for sales of real estate and in substance real estate. However, a conveyance of oil and gas mineral rights was and continues to be excluded from the scope of the referenced guidance. See ASC 932 for guidance on conveyances of oil and gas mineral rights and related transactions.

** This includes when an investee owns substantially all real estate or in substance real estate. The ASC 860 scope exception for sales of in substance real estate was removed by ASU 2017-05, which clarifies that the sale of an equity method investment in a real estate venture is no longer treated as an in substance sale of real estate. Instead, those transactions are required to be analyzed like any sale of an ownership interest subject to the sales of financial assets guidance in ASC 860.

6.2 Disposals by sale - 6.2.3 Allocating consideration in contracts partially within the scope of other topics

Publication date: 31 Jul 2020

In some transactions the contract may be partially within the scope of ASC 610-20 and partially within the scope of other topics. When nonfinancial assets are transferred directly (i.e., not through the sale of ownership interests in a legal entity) and do not represent substantially all of the fair value of the assets transferred, the contract may be partially within the scope of ASC 610-20 and partially within the scope of other guidance. Additionally, as discussed in PPE 6.2.1, guarantees that are in the scope of ASC 460 are also outside the scope of ASC 610-20. In such instances, the guidance in ASC 610-20-15-9 directs entities to consider the separation and allocation guidance within ASC 606. ASC 606-10-15-4 requires each part of the contract to be evaluated to determine if other applicable guidance specifies how to separate and measure the element. The portion of the contract for which other guidance specifically applies would be separated and/or initially measured based on that guidance. If the other guidance does not specifically address how to determine the consideration for the element, the allocation would be performed based on the relative standalone selling prices. See RR 2.2 for additional detail regarding how to identify and separate parts of a contract that are partially within the scope of ASC 606 and ASC 610-20. Each element would then be derecognized based on the relevant disposal model applicable to that element. Example PPE 6-7 provides an example of allocating consideration to each transferred element.

EXAMPLE PPE 6-7
Derecognition using multiple models 

Real Estate Corp enters into a contract to transfer several real estate-related assets to PPE Corp for $2,500. The asset group includes one wholly-owned office building (the nonfinancial asset) as well as several equity method investments holding similar real estate assets (the financial assets). The set is not a business, PPE Corp is not considered a customer, no liabilities are transferred with the set, and ownership in a legal entity that is (or has been) previously consolidated under ASC 810 was not transferred. The carrying and fair values of the assets promised are as follows (assume the fair value amounts are equal to the stand alone selling prices).

 

Carrying value

 

Fair value

Office building

$1,100

$1,350

Equity method investments

1,000

1,150

 

$2,100

 

$2,500

How would Real Estate Corp allocate the contract consideration between the components?

Analysis

Substantially all of the fair value of the assets promised in the contract is not concentrated in nonfinancial assets because of the significant amount of financial assets (i.e., equity method investments).

The office building would be derecognized using the nonfinancial asset guidance in ASC 610-20. The equity method investments would be derecognized using the financial asset guidance in ASC 860. Depending on the facts and circumstances and the application of the respective guidance in ASC 610-20 and ASC 860, these assets may not be derecognized at the same time. There may also be different disclosure or presentation requirements for assets that are derecognized under different topics. As a result, it would be necessary to separate and allocate consideration to each asset in the transaction.

Since ASC 860 does not specifically address the determination of the transaction price when a group of transferred assets includes assets within the scope of ASC 860, the separation and allocation guidance in ASC 606 should be applied. Accordingly, $1,350 of the transaction price would be allocated to the office building (the transaction price of $2,500 × 54% (standalone selling price of the office building of $1,350 / total standalone price of $2,500)). The remaining transaction price of $1,150 ($2,500 × 46%) would be allocated to the equity method investments, which would be derecognized in accordance with ASC 860.

6.2 Disposals by sale - 6.2.4 Derecognition of nonfinancial assets

Publication date: 31 Jul 2020

In order for a reporting entity to derecognize assets that are within the scope of ASC 610-20, the entity must transfer control of the assets to the counterparty. To determine if an entity has transferred control of the assets, the seller should first evaluate whether it has (or continues to have) a controlling financial interest under ASC 810 (see PPE 6.2.4.1).

If the reporting entity determines it does not have a controlling financial interest in either the entity that holds the assets (if ownership interests are transferred) or the counterparty (if the asset is directly transferred), the entity should evaluate whether the arrangement meets the contract criteria in ASC 606-10-25-1 (see PPE 6.2.4.2).

If the contract criteria are met, the reporting entity should next evaluate whether there are separate and distinct assets being transferred (see PPE 6.2.4.3). Each distinct asset will need to be evaluated to consider whether the counterparty obtains control over the distinct asset following the criteria in ASC 606 (see PPE 6.2.4.4). When the counterparty obtains control of the distinct asset, the asset will be derecognized, and the reporting entity will need to determine the resulting gain or loss upon derecognition (see PPE 6.2.5).

If the contract criteria are not met, the entity would continue to recognize the asset and apply the guidance in ASC 350-10-40-3 or ASC 360-10-40-3C. Additionally, the entity will record a liability for any consideration received and apply the guidance in ASC 606-10-25-8. Subsequently, the entity will continue to assess the contract to determine the point at which the contract criteria are met (see PPE 6.2.4.2).

When the contract criteria have been met, but the counterparty has not yet obtained control over the distinct asset, the entity will not derecognize the asset and will apply the guidance in ASC 606-10-45-2 to record a liability for any consideration received (see PPE 6.2.4.4).

Figure PPE 6-4 includes an overview of the guidance to consider when determining whether to derecognize an asset in the scope of ASC 610-20.

FIGURE PPE 6-4
Derecognition under ASC 610-20

Figure 6-4

6.2 Disposals by sale - 6.2.4 Derecognition of nonfinancial assets - 6.2.4.1 Assessing if the transferor has lost control in an asset disposal

Publication date: 31 Jul 2020

In accordance with ASC 610-20-25-2, a reporting entity should first assess whether it has lost control of the assets following the guidance under ASC 810. This analysis will differ based on whether the transferor sold the assets directly or indirectly through the transfer of a controlled subsidiary. If the assets are transferred directly, the transferor must not have a controlling financial interest in the transferee that receives the assets. If transferred indirectly through a controlled subsidiary, the transferor must relinquish control of the transferred subsidiary to demonstrate loss of control. For example, assume an entity that holds nonfinancial assets within a consolidated subsidiary that is not a business and sells a noncontrolling interest in that subsidiary to a third party (i.e., the entity continues to consolidate the subsidiary under ASC 810). If the selling entity controls the subsidiary before and after the transaction, the subsidiary would not be derecognized and will apply the guidance in ASC 810-10-45-21A through ASC 810-10-45-24. See CG 1.5.2.2 for the accounting considerations related to the loss of control.

Partial sales transactions

A long-lived asset may be partially disposed of either by sale or by other means, such as an exchange. In a partial sales transaction, an entity usually transfers control of a nonfinancial asset in exchange for a noncontrolling interest in the counterparty. Sometimes when a nonfinancial asset is held in a subsidiary and control is lost, a partial interest in the subsidiary is transferred in exchange for cash, and a noncontrolling interest in the subsidiary is retained.

Partial sales are most common in the real estate industry but also occur in other industries. Prior to the adoption of ASC 610-20, all partial sales of real estate were in the scope of ASC 360-20. Under ASC 360-20, the retained portion not subject to sale was held at its pro-rata carryover basis subsequent to the transaction and a gain or loss was only recorded to the extent of the sold portion. Under ASC 610-20, partial sales are not treated differently from other sales in the scope of the guidance. For example, when a partial sale transaction is within the scope of ASC 610-20 and the derecognition criteria have been met, the entire gain or loss on sale would be recorded. Example PPE 6-8 illustrates the accounting for a partial sale under ASC 610-20.

Under ASC 610-20, the consideration received by the seller in partial sales transactions will be measured using the concepts in ASC 606. For example, non-cash consideration (e.g., a noncontrolling interest in the buyer of the nonfinancial assets) will be measured at its fair value.

EXAMPLE PPE 6-8
Partial sale of real estate

PPE Corp owns 100% of an office building that is not a business and has a carrying value of $50 and a fair value of $100. PPE Corp transfers the entirety of its interest in the office building to Real Estate Corp for $60 and a 40% noncontrolling interest in Real Estate Corp, which held no assets or liabilities other than the cash required to purchase a 60% interest in the office building. As a result, the fair value of Real Estate Corp is $100 after the transfer. Prior to the transaction, Real Estate Corp is owned by an unrelated third party that is not a customer in this transaction.

How should PPE Corp determine the gain on the sale of the office building?

Analysis

PPE Corp's effective ownership interest in the office building is reduced from 100% to 40% as a result of the transaction. The noncontrolling interest (accounted for under the equity method) that PPE Corp has accepted as partial consideration for the transfer is valued at $40 ($100 fair value of Real Estate Corp × 40% ownership interest). Total consideration transferred is $100 ($60 in cash + $40 noncontrolling interest).

Consideration received is $100 and the building's previous carrying value was $50, so a gain of $50 would be recognized. The equity investment in Real Estate Corp would be recognized at its fair value of $40.

Partial sales transactions may occur when two or more parties form an accounting joint venture (or other entity) and no single party has a controlling financial interest. If any entity transfers nonfinancial assets to an accounting joint venture (i.e., a corporate joint venture, see CG 5 for further details) in return for an investment in the venture, it may recognize the full gain or loss under ASC 610-20. Whether the full gain or loss is recognized depends on whether the seller has transferred control of the assets to the joint venture. That is, for the purpose of determining whether control has transferred when an entity receives a noncontrolling interest in a legal entity in exchange for a nonfinancial asset, ASC 610-20-25-7 states that control should be obtained by the legal owner. Example PPE 6-9 provides an illustration of a partial sale transaction with an accounting joint venture following the adoption of ASC 610-20.

EXAMPLE PPE 6-9
Sale of nonfinancial asset to an accounting joint venture

PPE Corp and Manufacturing Corp form Venture Co, an accounting joint venture in which neither party is determined to have a controlling financial interest under ASC 810. In exchange for their ownership interests, PPE Corp and Manufacturing Corp contributed manufacturing equipment and cash, respectively. The sale of manufacturing equipment is not part of PPE Corp's ordinary business activities.

Should PPE Corp recognize a gain upon the sale of the manufacturing equipment to Venture Co?

Analysis

Yes. The transfer of nonfinancial assets to a joint venture will result in the loss of control by the transferor as PPE Corp does not have a controlling financial interest in Venture Co and Venture Co has gained control of the nonfinancial assets. The joint venture is not considered a customer as the sale of manufacturing equipment is not part of PPE Corp's ordinary business activities. If the joint venture is determined to have gained control of nonfinancial assets, PPE Corp would record (1) its investment in Venture Co at fair value and (2) the full gain or loss upon derecognition of the nonfinancial assets sold. Additionally, PPE Corp should consider whether the recognition of its interest in Venture Co at fair value results in any equity method basis differences (for example, if Venture Co recognizes the assets received at PPE Corp's historical cost).

6.2 Disposals by sale - 6.2.4 Derecognition of nonfinancial assets - 6.2.4.2 Determining whether the contract criteria have been met

Publication date: 31 Jul 2020

When assessing whether the transferee has gained control of an asset in the scope of ASC 610-20, the transferor must determine whether the contract criteria in ASC 606-10-25-1 have been met.

ASC 606-10-25-1

An entity shall account for a contract with a customer that is within the scope of this Topic only when all of the following criteria are met:

  1. The parties to the contract have approved the contract (in writing, orally, or in accordance with other customary business practices) and are committed to perform their respective obligations.

  2. The entity can identify each party's rights regarding the goods or services to be transferred.

  3. The entity can identify the payment terms for the goods or services to be transferred.

  4. The contract has commercial substance (that is, the risk, timing, or amount of the entity's future cash flows is expected to change as a result of the contract).

  5. It is probable that the entity will collect substantially all of the consideration to which it will be entitled in exchange for the goods or services that will be transferred to the customer (see paragraphs 606-10-55-3A through 55-3C). In evaluating whether collectibility of an amount of consideration is probable, an entity shall consider only the customer's ability and intention to pay that amount of consideration when it is due. The amount of consideration to which the entity will be entitled may be less than the price stated in the contract if the consideration is variable because the entity may offer the customer a price concession (see paragraph 606-10-32-7).

Each of these criteria are discussed further in RR 2.6.1.1 through RR 2.6.1.5.

The criteria that addresses collectability may be one of the more subjective areas in this analysis. When seller financing is provided as a part of the transaction, the asset being sold may serve as collateral for the financing (e.g., nonrecourse debt). As noted in ASC 606-10-55-3C, the entity's ability to repossess an asset transferred should not be considered for the purpose of assessing the entity's ability to mitigate its exposure to credit risk. For additional accounting considerations related to a financing component, refer to PPE 6.2.5.2.

If an arrangement does not meet all of the criteria in ASC 606-10-25-1, a contract does not exist for accounting purposes and a reporting entity should not derecognize the assets transferred. Instead, the reporting entity should continue to report the assets in its financial statements and apply the guidance in ASC 350-10-40-3 for any intangible assets or ASC 360-10-40-3C for any property, plant, and equipment. Subsequently, the reporting entity should continue to assess whether the contract criteria in ASC 606-10-25-1 have been met.

Any consideration received before the contract criteria have been met should be recorded as a liability until one of the events described in ASC 606-10-25-7 has occurred, or until the contract criteria in ASC 606-10-25-1 have been met. Refer to RR 2.6.2 for further discussion.

Example PPE 6-10 illustrates the accounting for nonrecourse seller financing when consideration is received prior to the derecognition of the nonfinancial asset.

EXAMPLE PPE 6-10
Sale of a nonfinancial asset subject to nonrecourse debt and consideration is received prior to derecognition

On January 16, 20X1, Manufacturing Corp sells a manufacturing facility with a carrying value of $1.2M to XYZ Corp for $5M. XYZ Corp makes a nonrefundable payment of $500,000 in conjunction with the transfer on January 16, 20X1. Manufacturing Corp provides nonrecourse debt for the remaining $4.5M.

The facility was closed prior to the sale and will require significant capital improvements before XYZ Corp can begin operating the facility. The nonrecourse debt is payable at the earlier of five years from the date of sale (i.e., January 16, 20X6), or one year from the commencement of operations at the facility. On January 16, 20X1, it is uncertain whether XYZ Corp will be able to generate sufficient cash proceeds at the facility to repay the nonrecourse debt of $4.5M.

On September 9, 20X1, XYZ Corp began operating the manufacturing facility. On December 31, 20X1, Manufacturing Corp concluded that it was probable that XYZ Corp will be able to repay the debt when due on September 9, 20X2. On December 31, 20X1, Manufacturing Corp also concluded that XYZ Corp obtained control over the asset following the guidance in ASC 606, as they obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from the asset (see PPE 6.2.4.4 for considerations regarding control).  

The terms of the nonrecourse debt, including the interest rate, are determined to be at market for this transaction. The accounting for interest has been excluded for the purposes of this example.

The transaction is not a sale to a customer, does not represent the sale of a business, and does not meet any of the other scope exceptions in ASC 610-20. As such, Manufacturing Corp has concluded that the transaction is within the scope of ASC 610-20.

How should Manufacturing Corp account for the sale of the manufacturing facility on January 16, 20X1 and on December 31, 20X1?

Analysis

On January 16, 20X1 and up until December 31, 20X1, the transaction does not meet the contract criteria under ASC 606-10-25-1 because Manufacturing Corp concluded that it is not probable that substantially all of the consideration is collectible. Although the debt is secured by the underlying asset (i.e., the manufacturing facility), the value of the asset cannot be taken into consideration when determining whether the consideration is collectible. The $500,000 that Manufacturing Corp received on the date of sale would be considered collectible, as it is nonrefundable; however, it does not represent substantially all of the contract consideration of $5M.

As a result, consistent with the guidance in ASC 360-10-40-3C, Manufacturing Corp would not derecognize the facility and would not record the note receivable. Given that the contract criteria have not been met and control of the asset (under ASC 606) has not transferred to the buyer, the consideration received of $500,000 will be recorded as a liability.

On December 31, 20X1, Manufacturing Corp has concluded that the contract criteria under ASC 606-10-25-1 have been met and that XYZ Corp has obtained control over the asset. As a result, Manufacturing Corp will derecognize the nonfinancial asset, record a gain on sale, and record a note receivable for the nonrecourse debt outstanding.

The following journal entry would be recorded on January 16, 20X1:

Dr. Cash

$500,000

Cr. Contract liability

$500,000


The following journal entry would be recorded on December 31, 20X1:

Dr. Note receivable

$4,500,000

Dr. Contract liability

$500,000

Cr. Manufacturing facility

$1,200,000*

Cr. Gain on sale

$3,800,000*


*The impact of any depreciation expense recorded during the period from January 19, 20X1 to December 31, 20X1 has been excluded. During this period, Manufacturing Corp would apply the guidance in ASC 360-10-40-3C to determine the appropriate amount of depreciation to record, if any.

6.2 Disposals by sale - 6.2.4 Derecognition of nonfinancial assets - 6.2.4.3 Identifying distinct assets

Publication date: 31 Jul 2020

Once a contract meets the criteria in ASC 606-10-25-1, the reporting entity should identify the distinct assets promised to the counterparty and derecognize each distinct asset once it has transferred control over it. See PPE 6.2.4.4 for further details regarding control. For many transactions within the scope of ASC 610-20, control over each asset in the contract will transfer at the same time (e.g., nonfinancial assets sold through the sale of a subsidiary). This means that the assets transferred would be derecognized at the same time. Therefore, in practice, the reporting entity may not need to separate and allocate the consideration to each distinct asset. However, for other transactions within the scope of ASC 610-20, control over each distinct asset may not transfer at the same time. This would result in those assets being derecognized at different points in time, making it necessary to separate and allocate consideration to each distinct asset in the transaction.

Each distinct asset is the unit of account for the purposes of applying the derecognition guidance and will form the basis for how and when the asset is derecognized. An asset is distinct when it meets both of the criteria in ASC 606-10-25-19. The first criteria is that the counterparty can benefit from the asset on its own or with other resources that are readily available. The second criteria is that the asset must be separately identifiable from other promises in the contract. For further discussion over these two criteria, refer to RR 3.4.

6.2 Disposals by sale - 6.2.4 Derecognition of nonfinancial assets - 6.2.4.4 Determining whether the transferee has gained control

Publication date: 31 Jul 2020

After determining that the transferor has lost control of the asset under ASC 810 (see PPE 6.2.4.1) and that the contract criteria in ASC 606 have been met (see PPE 6.2.4.2), ASC 610-20 requires the transferee to gain control under ASC 606 before the transferor can derecognize the distinct asset(s). ASC 606-10-25-25 defines control as "the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset," including the ability to prevent others from directing the use of the asset and obtaining the benefits from it. ASC 606-10-25-30 includes indicators to consider in determining when control of an asset transfers to the buyer.

ASC 606-10-25-30

If a performance obligation is not satisfied over time in accordance with paragraphs 606-10-25-27 through 25-29, an entity satisfies the performance obligation at a point in time. To determine the point in time at which a customer obtains control of a promised asset and the entity satisfies a performance obligation, the entity shall consider the guidance on control in paragraphs 606-10-25-23 through 25-26. In addition, an entity shall consider indicators of the transfer of control, which include, but are not limited to, the following:

  1. The entity has a present right to payment for the asset—If a customer presently is obliged to pay for an asset, then that may indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset in exchange.

  2. The customer has legal title to the asset—Legal title may indicate which party to a contract has the ability to direct the use of, and obtain substantially all of the remaining benefits from, an asset or to restrict the access of other entities to those benefits. Therefore, the transfer of legal title of an asset may indicate that the customer has obtained control of the asset. If an entity retains legal title solely as protection against the customer's failure to pay, those rights of the entity would not preclude the customer from obtaining control of an asset.

  3. The entity has transferred physical possession of the asset—The customer's physical possession of an asset may indicate that the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset or to restrict the access of other entities to those benefits. However, physical possession may not coincide with control of an asset. For example, in some repurchase agreements and in some consignment arrangements, a customer or consignee may have physical possession of an asset that the entity controls. Conversely, in some bill-and-hold arrangements, the entity may have physical possession of an asset that the customer controls. Paragraphs 606-10-55-66 through 55-78, 606-10-55-79 through 55-80, and 606-10-55-81 through 55-84 provide guidance on accounting for repurchase agreements, consignment arrangements, and bill-and-hold arrangements, respectively.

  4. The customer has the significant risks and rewards of ownership of the asset—The transfer of the significant risks and rewards of ownership of an asset to the customer may indicate that the customer has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. However, when evaluating the risks and rewards of ownership of a promised asset, an entity shall exclude any risks that give rise to a separate performance obligation in addition to the performance obligation to transfer the asset. For example, an entity may have transferred control of an asset to a customer but not yet satisfied an additional performance obligation to provide maintenance services related to the transferred asset.

  5. The customer has accepted the asset—The customer's acceptance of an asset may indicate that it has obtained the ability to direct the use of, and obtain substantially all of the remaining benefits from, the asset. To evaluate the effect of a contractual customer acceptance clause on when control of an asset is transferred, an entity shall consider the guidance in paragraphs 606-10-55-85 through 55-88.

All of the indicators do not need to be met for the entity to conclude that control has transferred. These indicators need to be evaluated collectively to determine whether they indicate that the transferee has obtained control over the distinct asset. This assessment should be focused primarily on the transferee's perspective. For further discussion related to these indicators, refer to RR 6.5.

In evaluating whether the transferee has obtained control, all terms of the contract need to be considered, including whether there are any post-sale restrictions or repurchase agreements (e.g., call options, forward options, put options). These arrangements are discussed in more detail in the following sections.

ASC 610-20-25-7 clarifies that when a reporting entity has a noncontrolling interest in the legal entity that acquires a distinct asset, the determination of whether the transferee has gained control is evaluated at the legal entity (i.e., transferee); that is, the determination is based on whether the legal entity has obtained control over the assets.

When a reporting entity concludes that the transferee has not yet obtained control over a distinct asset, the reporting entity will not derecognize the asset and subsequently, will continue to evaluate the guidance to determine the point at which the transferee obtains control over the asset. Any consideration received from the transferee, including any liabilities assumed by the transferee, in advance of obtaining control over the asset will be recorded as a contract liability following the guidance in ASC 610-20-45-2 and ASC 610-20-45-3.

Repurchase agreements

Under ASC 606-10-25-30(c), repurchase arrangements may preclude derecognition because while physical possession has transferred, another party has the right to dictate the future ownership of the asset, which indicates that control has not transferred. The accounting for a sale of a nonfinancial asset with a repurchase agreement depends on whether the agreement is (1) a seller repurchase right (i.e., a call option) or obligation (i.e., a forward agreement), or (2) a buyer repurchase right (i.e., a put option).

Call options and forward agreements

ASC 606 indicates that when a call option or forward agreement exists, a sale has not occurred and that the accounting for the arrangement is determined by the exercise price of the repurchase option. If the repurchase amount is greater than or equal to the original selling price, the arrangement should be accounted for as a financing transaction. If the repurchase amount is less than the original selling price, it should be accounted for as a lease, unless the contract is part of a sale-leaseback transaction. See RR 8.7.1 for further details.

If the arrangement is to be accounted for as a lease, the arrangement should be accounted for as a lease regardless of whether it meets the definition of a lease under ASC 842 (or ASC 840 prior to adoption). However, lease classification (operating, sales type, or direct financing) should be determined under the applicable leases guidance for each asset. Generally, when consideration transferred for the nonfinancial asset is greater than or equal to its carrying value, these arrangements would be accounted for as sales-type leases based on the lease accounting guidance, and the lessor would derecognize the nonfinancial asset despite control not being transferred under ASC 606 (and therefore ASC 610-20).

ASC 606 does not distinguish between the types of call options or discuss their specific terms. The implementation guidance and accompanying examples in ASC 610-20 and ASC 606 illustrate the accounting implications associated with fixed price call options that are exercisable by the seller without any restrictions. We believe there may be instances when the mere existence of a call option does not preclude sale accounting. The assessment of whether or not a call option precludes sale accounting should consider the substance of the call option. Factors that may impact whether the call option is substantive include the amount of the repurchase price (e.g., fixed, fair value, or formula priced) and its relationship to the fair value of the underlying asset(s), the presence and probability of any exercise contingencies associated with the option, and time to expiry, among other factors. Additionally, we believe that a fair value call option on a nonfinancial asset that is readily obtainable in the marketplace would not preclude sale accounting. However, not all call options with a fair value exercise price would result in sales treatment, as ASC 606 requires that the buyer obtains control of the asset.

We believe call options that are conditionally exercisable upon the occurrence of an event or other factors that are not within the control of the seller would not necessarily preclude sale accounting. In determining whether control has transferred to the buyer, reporting entities should evaluate the nature and conditions associated with the exercisability of the call option, the likelihood that the exercise conditions will be met, and whether the exercise conditions are based on factors outside the seller's control. A call option that is nonsubstantive also would not preclude sale treatment (absent other factors). For example, a deep out-of-the-money call option whose exercise is remote is unlikely to have economic substance.

Put options

Generally, put options would not preclude sale accounting, as the buyer is able to obtain control of the asset and has the option, but not the obligation, to require the seller to reacquire the nonfinancial asset. However, ASC 606 indicates that under certain circumstances, a sale may not occur and the arrangement would be required to be accounted for as a financing or lease (see lease considerations for call options). Consideration should be given to circumstances when the asset sold is unique or otherwise illiquid such that the buyer (i.e., option holder) may have a significant economic incentive to exercise the put option. See RR 8.7.2 for a detailed framework for evaluating put options. 

Post-sale restrictions

In considering whether a buyer has gained control of the transferred nonfinancial or in substance nonfinancial assets, ASC 606-10-25-30 notes that physical possession may indicate that the customer has the ability to direct the use of, and obtain substantially all of the remaining benefits from the transferred assets. However, physical possession may not always coincide with the buyer gaining control of the transferred assets. Consideration should be given to post-sale restrictions imposed by the seller that could directly or indirectly impede the buyer from otherwise directing the use of and obtaining substantially all of the remaining benefits from the transferred assets. Absent other factors, we generally would not expect that terms such as transfer restrictions when approval of the subsequent transfer is not to be unreasonably withheld, rights of first refusal, or regulatory limitations would preclude the buyer from obtaining control of the transferred nonfinancial or in substance nonfinancial assets under ASC 606-10-25-30.  

6.2 Disposals by sale - 6.2.5 Measuring the gain or loss on a disposal

Publication date: 31 Jul 2020

Once a reporting entity determines that it should derecognize an asset under ASC 610-20, the gain or loss on the transfer must be determined. The gain or loss is calculated as the difference between the consideration allocated to each distinct asset and its carrying amount. Refer to PPE 6.2.5.6 for details regarding the allocation of consideration to more than one distinct asset.

Nonfinancial assets will likely be subject to impairment testing prior to derecognition, therefore significant losses are not expected upon derecognition. See PPE 5 for details on impairment testing and PPE 5.3 for considerations related to held for sale accounting. 

Determining the consideration received in a contract can be complex as total consideration may not be for a fixed amount. See PPE 6.2.5.1 for discussion of variable consideration. The transaction may also include a financing component that may need to be separately accounted for. See PPE 6.2.5.2 for details. Total consideration may take various forms, such as noncash consideration (see PPE 6.2.5.3), consideration payable to the buyer (see PPE 6.2.5.4), or liabilities that are assumed or relieved by the buyer (see PPE 6.2.5.5).

6.2 Disposals by sale - 6.2.5 Measuring the gain or loss on a disposal - 6.2.5.1 Variable consideration

Publication date: 31 Jul 2020

Entities are required to estimate the amount of variable consideration to which they are entitled. Entities will need to estimate variable consideration, including contingent consideration associated with the sale, using either an expected value or most likely amount method (see RR 4.3.1). As discussed in ASC 606, variable consideration may take various forms including, but not limited to, price concessions, volume discounts, rebates, refunds, credits, incentives, performance bonuses, milestone payments, and royalties.

Variable consideration promised for a nonfinancial asset may include payments that are contingent upon the occurrence or nonoccurrence of one or more future events. Generally, these contingent payments should be accounted for as variable consideration. However, consideration should be given to whether the contingency is unrelated to the nonfinancial asset that is sold or the performance of one of the parties to the contract. In such cases, reporting entities should also consider whether the variable consideration arrangement is or contains a derivative that should be accounted for separately under ASC 815. See RR 4.3 for details regarding the recognition of variable consideration, including additional examples.

Variable consideration can only be included in a reporting entity's estimate of consideration when it is probable that the amount will not be subject to a significant reversal in the future (i.e. constraint on variable consideration). The assessment of whether variable consideration should be constrained is largely a qualitative one that has two elements: the magnitude and the likelihood of a change in estimate. The estimate of variable consideration and evaluation of the constraint on variable consideration should be reassessed at each reporting period, with any subsequent changes recorded in the income statement. See RR 4.3.2 for further details.

Example PPE 6-11 provides an example of variable consideration in a contract.

EXAMPLE PPE 6-11
Variable consideration subject to constraint

Pharma Corp sells rights to certain in-process research and development assets (IPR&D) that have a fair value of $100 million (book value of $75 million). Pharma Corp has concluded that the IPR&D assets are subject to the nonfinancial asset derecognition guidance because they do not comprise a business and are not an output of its ordinary activities that would be considered a contract with a customer. The buyer has agreed to pay $10 million in cash at closing and will pay a royalty equal to 3% of sales derived from the IPR&D for the next five years. The royalty payments to be received by Pharma Corp were determined to not be a freestanding or embedded derivative under ASC 815.

Derecognition is appropriate because Pharma Corp does not have a controlling financial interest in the buyer (under ASC 810), and the buyer has taken control of the IPR&D (under ASC 606).

What consideration should Pharma Corp recognize upon sale?

Analysis

Pharma Corp should recognize a $65 million contract loss on sale ($75 million carrying value less $10 million upfront payment). Although Pharma Corp can develop an estimate of the sales-based royalties and does not expect to ultimately incur a loss on this transaction, the variable consideration is considered "constrained" in accordance with ASC 606-10-32-11, as Pharma Corp cannot conclude it is probable that recognizing the variable royalties in other income would not result in a significant reversal. (Note that the constraint on estimates of variable consideration is different than the narrow exception granted for licenses of intellectual property with consideration in the form of sale or usage-based royalties whereby such royalties are not recognized until usage occurs. See RR 4.3.5 for details.) Pharma Corp should update its estimate at each reporting date until the uncertainty associated with the royalties is resolved . In subsequent periods, Pharma Corp should reassess the variable consideration and record other income for any amount that is no longer subject to the "constraint."

6.2 Disposals by sale - 6.2.5 Measuring the gain or loss on a disposal - 6.2.5.2 Significant financing component

Publication date: 31 Jul 2020

In certain situations, consideration may be transferred significantly before or significantly after the buyer obtains control of the nonfinancial asset. These contracts may contain either an explicit or implicit financing component. This financing component should be assessed to determine whether it represents a significant financing component that needs to be recorded. The amount of consideration may need to be adjusted for the time value of money by discounting it, with an appropriate discount rate, over the expected payment period and recording the difference over time as either interest income or expense, as appropriate. Any explicit rate in the contract should be assessed to determine if it represents a prevailing rate for a similar transaction, or if a more representative rate should be imputed. See RR 4.4 for further details.

The guidance in ASC 606-10-32-18 provides a practical expedient that allows entities to disregard the effects of a financing component if the entity expects, at contract inception, that the period between when the entity transfers the asset and when the counterparty pays for that asset will be one year or less. See RR 4.4.2 for further details.

6.2 Disposals by sale - 6.2.5 Measuring the gain or loss on a disposal - 6.2.5.3 Noncash consideration

Publication date: 31 Jul 2020

Noncash consideration transferred, such as equity shares or inventory, needs to be measured at fair value at contract inception and included when determining the transaction price (i.e., when the transfer has met the criteria in ASC 606-10-25-1). This may be different than the date when the noncash consideration is received by the transferor. See RR 4.5 for details.

The reporting entity may not be able to reliably determine the fair value of noncash consideration in some situations. In this case the value of the noncash consideration received should be measured indirectly by reference to the standalone selling price of the assets transferred by the reporting entity.

6.2 Disposals by sale - 6.2.5 Measuring the gain or loss on a disposal - 6.2.5.4 Consideration payable to a counterparty

Publication date: 31 Jul 2020

An entity might pay, or expect to pay, consideration to the buyer. The consideration payable can be cash, either in the form of rebates or upfront payments, or could alternatively be a credit or some other form of incentive that reduces amounts owed to the entity by a counterparty. Consideration payable to a counterparty is recorded as a reduction of the consideration transferred, unless the payment is for a distinct good or service received from the counterparty. See RR 4.6.1 for further details.

6.2 Disposals by sale - 6.2.5 Measuring the gain or loss on a disposal - 6.2.5.5 Liabilities that are assumed or relieved

Publication date: 31 Jul 2020

As noted in ASC 610-20-32-5, if a counterparty promises to assume or relieve a liability of an entity in exchange for a transfer of assets, the transferring entity should include the carrying amount of the liability in the consideration used to calculate the gain or loss on the net asset sale.

As discussed in ASC 610-20-45-3, a reporting entity will apply other guidance to derecognize the liability (e.g., ASC 450). If a reporting entity transfers control of an asset before derecognizing a liability assumed by a counterparty, the reporting entity would recognize a contract asset to the extent the carrying amount of the liability is included in the calculation of the gain or loss. Conversely, if a reporting entity transfers control of an asset after derecognizing a liability assumed by a counterparty, the reporting entity would recognize a contract liability.

A reporting entity is still required to perform impairment testing in accordance with applicable guidance for the assets to be disposed (e.g., ASC 360, ASC 350) prior to derecognition. For example, nonfinancial assets subject to nonrecourse debt that are determined to be impaired under ASC 360 may need to be written down to fair value that is less than the carrying value of the debt. Often, this occurs in foreclosures of real estate. In situations when the real estate has been written down to a value below the carrying amount of the debt, a net gain upon derecognition will result, largely comprised of a gain on debt forgiveness. See Example PPE 5-7 in PPE 5.2.5 for additional considerations for debt in impairment testing.

6.2 Disposals by sale - 6.2.5 Measuring the gain or loss on a disposal - 6.2.5.6 Allocating consideration to more than one distinct asset

Publication date: 31 Jul 2020

When a contract includes the transfer of more than one distinct asset, an entity should allocate the consideration to each distinct asset in accordance with ASC 606-10-32-28 through ASC 606-10-32-41. Generally, this means that the consideration will be allocated to the distinct assets based on their relative standalone selling price. The objective is for an entity to allocate the consideration in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the distinct asset to the counterparty. For further details on the determination of the standalone selling price and other considerations related to the allocation of consideration, refer to RR 5.

6.3 Transitioning to ASC 610-20

Publication date: 31 Jul 2020

The amendments to the nonfinancial asset guidance contained in ASC 610-20 are effective at the same time a reporting entity adopts the revenue guidance in ASC 606.

Reporting entities may transition to ASC 610-20 using either of the following methods:

  • The full retrospective approach (i.e., applied retrospectively to all prior periods presented)

  • The modified retrospective approach (i.e., applied retrospectively by recording the cumulative effect of the change at the beginning of the period of adoption), regardless of the transition approach elected under ASC 606

Additionally, for reporting entities that adopt ASC 610-20 (and related amendments in ASU 2017-05) under the full retrospective method, the new guidance provides the following practical expedients (see ASC 606-10-65-1) in an effort to ease the burden of transition:

  • Entities do not need to estimate variable consideration at the time of sale for completed contracts and can use the actual transaction price

  • Entities do not need to retrospectively restate for contracts modified before the earliest period presented at adoption

  • If upon adoption of ASC 610-20, an entity concludes that a transaction previously recorded as the disposal of a business does not qualify as a business under ASU 2017-01, the entity will not need to reinstate amounts previously allocated to goodwill associated with the disposed business

Reporting entities may elect to apply practical expedients for the adoption of ASC 610-20 that differ from the elections made for the adoption of ASC 606. Under the full retrospective transition method, ASC 610-20 will apply to all contracts. However, if modified retrospective transition is chosen, a reporting entity can make an election to not apply the guidance to "completed contracts." The guidance defines a completed contract as a contact in which all or "substantially all" of the revenue from the contract was recognized under accounting guidance prior to the adoption of ASC 606 and 610-20.

Reporting entities may not have a cumulative effect adjustment upon adopting ASC 610-20 as contracts within its scope are oftentimes completed upon execution. However, contracts are not "completed," for example, when a significant amount of variable consideration can be received after ASC 610-20 is adopted. If a contract is not completed, entities should estimate the transaction price, including variable consideration, and recognize the sale in accordance with guidance for contracts with customers in ASC 606. See RR 4.3 and RR 5.5 for details.

Another scenario to consider is when the seller has a call option to repurchase a nonfinancial asset that has not been exercised/terminated at the date of adoption, as the asset may not be derecognized prior to the date of adoption. In such cases, an entity should consider the guidance in PPE 6.2.5.3 for nonfinancial assets subject to call or repurchase options.

In partial sale transactions, the retention of an equity method investment does not suggest that the contract is "not completed" even though the gain would have been limited under the guidance prior to the adoption of ASC 610-20. If the partial sale occurred in 2017, assuming a January 1, 2018 adoption date and using the modified retrospective transition method, the retained interest will not change and no cumulative effect adjustment will be recorded. If the full retrospective transition method is utilized, the new guidance would be followed for the partial sale transaction.

A reporting entity should consider the ongoing impact of choosing either transition method. One example of a future consequence of the transition method is that depreciation and amortization charges are likely to increase under the full retrospective method. In addition, a partial sale usually results in a higher equity method investment balance upon adoption under the full retrospective transition method as the retained interest is recorded at fair value, which may increase the potential for impairment.

6.4 Disposals other than by sale

Publication date: 31 Jul 2020

A long-lived asset is often disposed of by means that do not include a sale. This section discusses disposals by abandonment (see PPE 6.4.1), nonreciprocal transfers to owners, for example a spinoff or split-off (see PPE 6.4.2), and involuntary conversions (see PPE 6.4.3).

6.4 Disposals other than by sale - 6.4.1 Accounting for long-lived assets to be abandoned

Publication date: 31 Jul 2020

A long-lived asset to be abandoned is considered disposed of when it ceases to be used. For example, equipment that a reporting entity plans to dispose of, but only after it is used to fulfill current orders, is not considered abandoned while it is still in use because the reporting entity receives an ongoing benefit from the equipment. Further, a temporarily idled asset is not considered abandoned as the asset will be used in the future.

If a reporting entity commits to a plan to abandon a long-lived asset before the end of its previously estimated useful life, it should first test the asset for impairment. The reporting entity should then revise its future depreciation to reflect the use of the asset over its shortened remaining useful life. Therefore, while the broader asset group may not fail the recoverability test, adjustment of the useful life of the to-be-abandoned asset may still be necessary in accordance with ASC 360-10-35-47. However, ASC 360-10-35-48 states that only in unusual situations is the fair value of a long-lived asset to be abandoned zero while it is still being used. When the long-lived asset is actually abandoned, its carrying value should equal zero or its salvage value, if any.

Example PPE 6-12 illustrates the accounting for an asset to be abandoned.

EXAMPLE PPE 6-12
Accounting for an asset to be abandoned

Manufacturing Co has machines used in its manufacturing process that it plans to abandon when the upgraded replacement machines are delivered and placed in service. No proceeds are expected upon abandonment. The original machines were placed in service three years ago and are being depreciated on a straight-line basis over 10 years, with no salvage value expected at the end of 10 years. Abandonment cannot occur prior to the receipt and installation of the replacement machines, which is expected to occur in December 20X8. Management began re-evaluating the efficiency of the original machines in early 20X7. It had included in its 20X8 capital expenditures budget, which was finalized and approved in June 20X7, an estimated amount to purchase the new machines. The existing machines, when grouped with other assets at the lowest level of identifiable cash flows, were not impaired on a held-and-used basis throughout this period.

How should Manufacturing Co account for the assets to be abandoned?

Analysis

Because the machines will remain in use through December 20X8, the assets should not be considered abandoned until that time. The asset group that includes the machine is not impaired on a held-and-used basis, so no impairment loss should be recognized at the time Manufacturing Co decides it will abandon the machines. However, because Manufacturing Co plans to abandon the machines before the end of their previously estimated useful lives of 10 years, the useful lives of the assets should be adjusted in June 20X7, when Manufacturing Co commits to a plan to abandon the machines. As a result, Manufacturing Co would depreciate the remaining carrying amounts of the machines over their revised useful lives of approximately 18 months.

6.4 Disposals other than by sale - 6.4.1 Accounting for long-lived assets to be abandoned - 6.4.1.1 Lease abandonment considerations (under ASC 842)

Publication date: 31 Jul 2020

As discussed in PPE 4.2.5, the subsequent measurement of a right-of-use asset is subject to the guidance in ASC 842 and ASC 360. Refer to LG 4.4, for further details regarding the subsequent recognition and measurement of a lease under ASC 842. A right-of-use asset is a long-lived asset and is also subject to the Impairment or Disposal of Long-Lived Assets subsection of ASC 360, which includes guidance related to the impairment and useful lives of long-lived assets. A right-of-use asset may be abandoned, similar to any other long-lived asset. See PPE 6.4.1 for additional considerations regarding the abandonment of long-lived assets.

A temporarily idled right-of-use asset is not considered abandoned as the asset will be used in the future. For example, a decision to sublease a right-of-use asset does not constitute an abandonment of the right-of-use asset as the lessee still intends to obtain economic benefits from the asset, just in a different capacity.

When a lessee determines that it has committed to a plan to abandon a right-of-use asset, adjustment of the useful life of the to-be-abandoned asset may be necessary. The useful life assessment of a long-lived asset is based on the lessee's assumption of the length over which it intends to use the asset (see PPE 4.2.5 for further discussion on the determination of useful life). A decision to abandon a right-of-use asset may be an indicator that an impairment test is required for the asset group. See PPE 5.2.6 for a discussion on lease impairment considerations.

If a right-of-use asset has not been impaired but its useful life has been shortened, one acceptable approach to subsequently account for the lease is to follow the accounting for a right-of-use asset that has been impaired, in which case amortization of the right-of-use asset and lease liability would be delinked in the subsequent accounting (see PPE 5.2.6.3). Example PPE 6-13 illustrates this delinked approach to account for the change in the remaining useful life of a right-of-use asset when it has not been impaired.

Another acceptable approach to subsequently account for the lease is to retain the linkage between the right-of-use asset amortization and the lease liability. In this case, the straight-line lease expense should be remeasured over the shortened useful life, which is consistent with the guidance in ASC 842-20-25-6(a). Example PPE 6-14 illustrates this linked approach to account for the change in the remaining useful life of a right-of-use asset when it has not been impaired.

EXAMPLE PPE 6-13
Accounting for a right-of-use asset to be abandoned (delinked approach)

Lessee Corp leases a specialized facility in a remote location from Lessor Corp on January 1, 20X0. Lessee Corp determines that the lease is an operating lease. The following table summarizes information about the lease and the leased asset.

Lease term

8 years, no renewal option

Economic life of the building

40 years

Purchase option

None

Monthly lease payments

No lease payments are due for the first three months; the remaining monthly lease payments are $200,000

Payment date

Beginning of the month

Lessee Corp's incremental borrowing rate

6%. The rate Lessor Corp charges Lessee Corp in the lease is not readily determinable by Lessee Corp

Other

There are no additional provisions in the lease that would impact its classification or measurement


How would Lessee Corp measure and record this lease?

Analysis

Lessee Corp would first calculate the lease liability as the present value of the remaining unpaid monthly fixed lease payments discounted at Lessee Corp's incremental borrowing rate of 6%; this amount is $14,624,994. The ROU asset is equal to the lease liability on the lease commencement date. Lessee Corp would record the following journal entry on the lease commencement date.

Dr. ROU asset

$14,624,994

 

Cr. Lease liability

 

$14,624,994

Because Lessee Corp is required to pay $200,000 per month for eight years (excluding the first three months), the total lease payments are $18,600,000 ($200,000 × 93 months). Lessee Corp would then calculate the straight-line lease expense to be recorded each period by dividing the total lease payments by the total number of periods. The monthly straight-line expense would be $193,750 ($18,600,000/96 months).

Lessee Corp would calculate the amortization of the lease liability as shown in the following table. This table is shown on an annual basis for simplicity; the schedule would be calculated on a monthly basis to reflect the frequency of the lease payments.

 

Payment

Interest on the
lease liability*

Lease liability

Lease commencement

 

 

$14,624,994

Year 20X0

$1,800,000

$865,614

13,690,608

Year 20X1

2,400,000

777,295

12,067,903

Year 20X2

2,400,000

677,209

10,345,112

Year 20X3

2,400,000

570,951

8,516,063

Year 20X4

2,400,000

458,140

6,574,203

Year 20X5

2,400,000

338,370

4,512,573

Year 20X6

2,400,000

211,213

2,323,786

Year 20X7

2,400,000

76,214

__

 

$18,600,000

$3,975,006

 

*Although these amounts are labelled as "interest," there is no interest expense recorded in the income statement. These amounts are calculated based on the lease liability on a monthly basis in order to determine the ending balance of the lease liability; however, there is only one straight-line lease expense recorded in the income statement. See LG 4.4.2 for additional information.

The amortization of the right-of-use asset is calculated as the difference between the straight-line lease expense ($193,750 per month) and the interest calculated on the lease liability. The following table shows this calculation. This table is shown on an annual basis for simplicity; the schedule would be calculated on a monthly basis to reflect the frequency of the lease payments.

 

Straight-line expense
(A)

Interest on lease liability
(B)

Amortization
(A - B)

ROU asset

Lease commencement

 

 

 

$14,624,994

Year 20X0

$2,325,000

$865,614

$1,459,386

13,165,608

Year 20X1

2,325,000

777,295

1,547,705

11,617,903

Year 20X2

2,325,000

677,209

1,647,791

9,970,112

Year 20X3

2,325,000

570,951

1,754,049

8,216,063

Year 20X4

2,325,000

458,140

1,866,860

6,349,203

Year 20X5

2,325,000

338,370

1,986,630

4,362,573

Year 20X6

2,325,000

211,213

2,113,787

2,248,786

Year 20X7

2,325,000

76,214

2,248,786

__

 

$18,600,000

$3,975,006

$14,624,994

 

For the year ended December 31, 20X0, the following cumulative journal entries would have been recorded by Lessee Corp.

Dr. Lease expense

$2,325,000

 

Dr. Lease liability

$934,386

 

Cr. ROU asset

 

$1,459,386

Cr. Cash

 

$1,800,000


If on December 31, 20X4, Lessee Corp determines that it will only use the facility through December 31, 20X5 (assume Lessee Corp has concluded that the residual value will be $0), Lessee Corp would adjust the remaining useful life to one year. Doing so has no impact on the accounting for the lease liability. However, the change in the useful life would impact the accounting for the ROU asset and its subsequent amortization.

On December 31, 20X4, Lessee Corp would calculate the straight-line amortization of the right-of-use asset to be recorded each period for the remaining useful life by dividing the right-of-use asset balance ($6,349,203) by the remaining useful life (one year). The monthly straight-line amortization for the remaining useful life of the right-of-use asset would be $529,100 ($6,349,203/12 months). Subsequent to December 31, 20X5, the monthly lease expense would be equal to the effective interest on the lease liability for the remainder of the lease term.

The following table show the annual accounting amortization and calculation. This table is shown on an annual basis for simplicity; the schedule would be calculated on a monthly basis to reflect the frequency of the lease payments.

 

Lease expense
(A+B)

Interest on lease liability
(A)

Amortization
(B)

ROU
asset

Year 20X4

 

 

 

$6,349,203

Year 20X5

$6,687,573

$338,370

$6,349,203

__

Year 20X6

211,213

211,213

__

__

Year 20X7

76,214

76,214

__

__

 

$6,975,000

$625,797

$6,349,203

 

For the year ended December 31, 20X5, the following cumulative journal entries would have been recorded by Lessee Corp.

Dr. Lease expense

$6,687,573

 

Dr. Lease liability

$2,061,630

 

Cr. ROU asset

 

$6,349,203

Cr. Cash

 

$2,400,000

For the year ended December 31, 20X6, the following cumulative journal entries would have been recorded by Lessee Corp.

Dr. Lease liability

$2,188,787

 

Dr. Lease expense

   $211,213

 

Cr. Cash

 

$2,400,000

EXAMPLE PPE 6-14
Accounting for a right-of-use asset to be abandoned (linked approach)

Lessee Corp leases a specialized facility in a remote location from Lessor Corp on January 1, 20X0. Lessee Corp determines that the lease is an operating lease. The following table summarizes information about the lease and the leased asset.

Lease term

8 years, no renewal option

Economic life of the building

40 years

Purchase option

None

Monthly lease payments

No lease payments are due for the first three months, the remaining monthly lease payments are $200,000

Payment date

Beginning of the month

Lessee Corp's incremental borrowing rate

6%. The rate Lessor Corp charges Lessee Corp in the lease is not readily determinable by Lessee Corp

Other

There are no additional provisions in the lease that would impact its classification or measurement

How would Lessee Corp measure and record this lease?

Analysis

Lessee Corp would first calculate the lease liability as the present value of the remaining unpaid monthly fixed lease payments discounted at Lessee Corp's incremental borrowing rate of 6%; this amount is $14,624,994. The ROU asset is equal to the lease liability on the lease commencement date. Lessee Corp would record the following journal entry on the lease commencement date.

Dr. ROU asset

$14,624,994

 

Cr. Lease liability

 

$14,624,994

Because Lessee Corp is required to pay $200,000 per month for eight years (excluding the first three months), the total lease payments are $18,600,000 ($200,000 × 93 months). Lessee Corp would then calculate the straight-line lease expense to be recorded each period by dividing the total lease payments by the total number of periods. The monthly straight-line expense would be $193,750 ($18,600,000/96 months).

Lessee Corp would calculate the amortization of the lease liability as shown in the following table. This table is shown on an annual basis for simplicity; the schedule would be calculated on a monthly basis to reflect the frequency of the lease payments.

 

Payment

Interest on the
lease liability*

Lease liability

Lease commencement

 

 

$14,624,994

Year 20X0

$1,800,000

$865,614

13,690,608

Year 20X1

2,400,000

777,295

12,067,903

Year 20X2

2,400,000

677,209

10,345,112

Year 20X3

2,400,000

570,951

8,516,063

Year 20X4

2,400,000

458,140

6,574,203

Year 20X5

2,400,000

338,370

4,512,573

Year 20X6

2,400,000

211,213

2,323,786

Year 20X7

2,400,000

76,214

__

 

$18,600,000

$3,975,006

 

*Although these amounts are labelled as "interest," there is no interest expense recorded in the income statement. These amounts are calculated based on the lease liability on a monthly basis in order to determine the ending balance of the lease liability; however, there is only one straight-line lease expense recorded in the income statement. See LG 4.4.2 for additional information.

The amortization of the right-of-use asset is calculated as the difference between the straight-line lease expense ($193,750 per month) and the interest calculated on the lease liability. The following table shows this calculation. This table is shown on an annual basis for simplicity; the schedule would be calculated on a monthly basis to reflect the frequency of the lease payments.

 

Straight-line expense
(A)

Interest on lease liability
(B)

Amortization
(A - B)

ROU asset

Lease commencement

 

 

 

$14,624,994

Year 20X0

$2,325,000

$865,614

$1,459,386

13,165,608

Year 20X1

2,325,000

777,295

1,547,705

11,617,903

Year 20X2

2,325,000

677,209

1,647,791

9,970,112

Year 20X3

2,325,000

570,951

1,754,049

8,216,063

Year 20X4

2,325,000

458,140

1,866,860

6,349,203

Year 20X5

2,325,000

338,370

1,986,630

4,362,573

Year 20X6

2,325,000

211,213

2,113,787

2,248,786

Year 20X7

2,325,000

76,214

2,248,786

__

 

$18,600,000

$3,975,006

$14,624,994

 

For the year ended December 31, 20X0, the following cumulative journal entries would have been recorded by Lessee Corp.

Dr. Lease expense

$2,325,000

 

Dr. Lease liability

$934,386

 

Cr. ROU asset

 

$1,459,386

Cr. Cash

 

$1,800,000


If on December 31, 20X4, Lessee Corp determines that it will only use the facility through December 31, 20X5 (assume Lessee Corp has concluded that the residual value will be $0), Lessee Corp would adjust the remaining useful life to one year. Doing so has no impact on the accounting for the lease liability. However, the change in the useful life would impact the accounting for the ROU asset and the straight-line expense.

On December 31, 20X4, Lessee Corp would calculate the straight-line lease expense to be recorded each period for the remaining useful life by dividing the right-of-use asset balance ($6,349,203) and the remaining interest on the lease liability ($625,797) by the remaining useful life (one year). The monthly straight-line lease expense for the remaining useful life of the right-of-use asset would be $581,250 (($6,349,203 + $625,797)/12 months). Subsequent to December 31, 20X5, the monthly straight-line lease expense would be $0 for the remainder of the lease term.

The amortization of the ROU asset would be calculated as the difference between the straight-line lease expense and the interest calculated on the lease liability. The following table shows this calculation. This table is shown on an annual basis for simplicity; the schedule would be calculated on a monthly basis to reflect the frequency of the lease payments.

 

Straight-line expense
 (A)

Interest on lease liability
(B)

Amortization
(A - B)

ROU
asset

Year 20X4

 

 

 

$6,349,203

Year 20X5

$6,975,000

$338,370

$6,636,630

(287,427)*

Year 20X6

__

211,213

(211,213)

(76,214)*

Year 20X7

__

76,214

(76,214)

__

 

$6,975,000

$625,797

$6,349,203

 

* When an ROU asset is negative it is presented as a liability.

For the year ended December 31, 20X5, the following cumulative journal entries would have been recorded by Lessee Corp.

Dr. Lease expense

$6,975,000

 

Dr. Lease liability

$2,061,630

 

Cr. ROU asset

 

$6,636,630

Cr. Cash

 

$2,400,000

For the year ended December 31, 20X6, the following cumulative journal entries would have been recorded by Lessee Corp.

Dr. Lease liability

$2,188,787

 

Dr. ROU asset

   $211,213

 

Cr. Cash

 

$2,400,000

6.4 Disposals other than by sale - 6.4.2 Nonreciprocal transfer of assets in a spinoff

Publication date: 31 Jul 2020

A nonreciprocal transfer of assets to owners of a reporting entity could be in the form of a pro rata spinoff or a non-pro rata split-off. Nonreciprocal transfers of assets in a split-off are discussed in PPE 6.4.3.

ASC 505-60-20 defines a spinoff.

Definition from ASC 505-60-20

Spinoff: The transfer of assets that constitute a business by an entity (the spinnor) into a new legal spun-off entity (the spinnee), followed by a distribution of the shares of the spinnee to its shareholders, without the surrender by the shareholders of any stock of the spinnor.

In accordance with ASC 845-10-30-10, a transfer of long-lived assets that constitute a business to owners in a spinoff should be accounted for based on the recorded amount of the assets transferred (after reduction, if appropriate, for any impairment). In contrast, if the long-lived assets transferred do not constitute a business, the transaction is not a spinoff even though the distribution is pro rata. Rather, it would be considered a dividend in kind, which is generally accounted for based on the fair value of the assets transferred.

If a long-lived asset is to be disposed of in an exchange or a distribution to owners in a spinoff, and if that exchange or distribution is to be accounted for based on the recorded amount of the nonmonetary asset relinquished, the asset should continue to be accounted for as held and used until it is exchanged or distributed. If a reporting entity tests that asset for recoverability while it is classified as held and used, the estimates of future cash flows that are used in that test should be based on the use of the asset for its remaining useful life, assuming that the exchange or distribution transaction will not occur. In accordance with ASC 360-10-40-4, in addition to any impairment losses a reporting entity is required to recognize while the long-lived asset is classified as held and used, an impairment loss should also be recognized when the asset is disposed of if the carrying amount of the disposal group exceeds its fair value.

ASC 505-60 addresses whether or not to account for a spinoff as a reverse spinoff based on the substance instead of the legal form of the transaction. There is a rebuttable presumption that the spinoff should be accounted for based on its legal form (i.e., the legal spinnor is also the accounting spinnor). ASC 505-60-25-8 provides several indicators to consider when deciding if the presumption to account for the transaction based on legal form should be overcome. However, no single indicator should be considered presumptive or determinative. When the indicators are mixed, judgment will be required to determine whether the presumption has been overcome and the substance of the transaction is a reverse spin.

Excerpt from ASC 505-60-25-8

  1. The size of the legal spinnor and the legal spinnee. All other factors being equal, in a reverse spinoff, the accounting spinnor (legal spinnee) is larger than the accounting spinnee (legal spinnor). The determination of which entity is larger is based on a comparison of the assets, revenues, and earnings of the two entities. There are no established bright lines that shall be used to determine which entity is the larger of the two.

  2. The fair value of the legal spinnor and the legal spinnee. All other factors being equal, in a reverse spinoff, the fair value of the accounting spinnor (legal spinnee) is greater than that of the accounting spinnee (legal spinnor).

  3. Senior management. All other factors being equal, in a reverse spinoff, the accounting spinnor (legal spinnee) retains the senior management of the formerly combined entity. Senior management generally consists of the chairman of the board, chief executive officer, chief operating officer, chief financial officer, and those divisional heads reporting directly to them, or the executive committee if one exists.

  4. Length of time to be held. All other factors being equal, in a reverse spinoff, the accounting spinnor (legal spinnee) is held for a longer period than the accounting spinnee (legal spinnor). A proposed or approved plan of sale for one of the separate entities concurrent with the spinoff may identify that entity as the accounting spinnee.

For SEC registrants that have concluded that a transaction should be accounted for as a reverse spinoff, a question arises as to whether the financial statements of the existing registrant (i.e., the legal spinnor/accounting spinnee) can be used to satisfy the financial statement requirements of the entity that will be spun off (i.e., the accounting spinnor/legal spinnee). In an SEC staff speech, the staff expressed its view that this assessment should be based on the unique facts and circumstances of each transaction, and there may be situations in which carve-out financial statements are required for the accounting spinnor/legal spinnee. See FSP 27.4.3.1 for further discussion of the presentation of spinoff transactions. 

6.4 Disposals other than by sale - 6.4.3 Nonreciprocal transfer of assets in a split-off

Publication date: 31 Jul 2020

A nonreciprocal transfer of assets to owners of a reporting entity could be in the form of a pro rata spinoff or a non-pro rata split-off. Nonreciprocal transfers of assets in a spinoff are discussed in PPE 6.4.2.

A split-off transaction is a non-pro rata distribution that may or may not involve all shareholders. A split-off transaction usually involves a substantive parent entity offering its noncontrolling shareholders the ability to exchange any or all of their equity shares of the parent entity, subject to a cap if oversubscribed, for shares of a subsidiary at a specified exchange rate. A non-pro rata split-off is akin to a sale. ASC 845-10-20 defines a split-off.

Definition from ASC 845-10-20

Split-off:A transaction in which a parent entity exchanges its stock in a subsidiary for parent entity stock held by its shareholders.

Non-pro rata split-off transactions that are accounted for under ASC 845-10-30-12 are based on the fair value of the assets transferred, regardless of whether the subsidiary being split-off constitutes a business in a corporate plan of reorganization. A split-off of nonfinancial assets and in substance nonfinancial assets is accounted for under ASC 610-20. See PPE 6.2.5 for details regarding the determination of the transaction price. A split-off to a controlling shareholder is a common control transaction and would be accounted for based on the recorded amount of the assets transferred.

Since a split-off transaction is akin to a sale transaction, the long-lived asset impairment test should be performed in accordance with the held for sale guidance at the time the long-lived asset is classified as held for sale. See PPE 5.3.3.

6.4 Disposals other than by sale - 6.4.4 Involuntary conversions

Publication date: 31 Jul 2020

Involuntary conversions of nonmonetary assets to monetary assets are considered monetary transactions. Examples of such conversions are total or partial destruction or theft of insured long-lived assets and the condemnation of property in eminent domain proceedings. Any gain or loss from the conversion should be fully recognized as a component of income, even if the reporting entity reinvests or is obligated to reinvest the recovery in a replacement long-lived asset. Often, losses from involuntary conversions are covered by insurance. See PPE 8.2 for further information on insurance recoveries. Additionally, ASC 606 reorganized the guidance for involuntary conversions, moving it from ASC 605-40 to ASC 610-30.

6.4 Disposals other than by sale - 6.4.5 Donations of long-lived assets

Publication date: 31 Jul 2020

The donation of a long-lived asset or disposal group is also considered a disposal by other than sale and would follow the held and used accounting model until disposal in accordance with ASC 360-10-45-15.

6.4 Disposals other than by sale - 6.4.6 Exchanges of nonmonetary assets

Publication date: 31 Jul 2020

Subsequent to the adoption of ASC 606 and ASC 610-20, the guidance in ASC 845 will exclude transactions with customer or non-customers in exchange for noncash consideration. Accordingly, many nonmonetary transactions will be in the scope of ASC 606 and ASC 610-20. The consideration transferred will include noncash consideration (i.e., nonmonetary assets) measured at its fair value at contract inception (see RR 4.5.1 for details). ASC 610-20 does not amend existing practice for nonreciprocal transfers with owners (see PPE 6.4.2) and non-derivative purchases and sales of inventory with the same counterparty, in which case qualifying transactions are recognized at the carrying amount of the inventory transferred (see ASC 845-10-30-15 through ASC 845-10-30-16). See PPE 2.3.1.1 for details regarding the accounting for an asset acquired in a nonmonetary exchange.

6.5 Disposal activities, exit costs, and restructuring charges

Publication date: 31 Jul 2020

ASC 420-10, Exit or Disposal Cost Obligations, addresses significant issues related to the recognition, measurement, and reporting of costs associated with exit and disposal activities, including restructuring activities. ASC 420-10 focuses on the recognition of liabilities, specifically requiring that companies only record liabilities when they are incurred. 

ASC 360-10, not ASC 420-10, governs the accounting for the impairment of long-lived assets and assets to be disposed of. See PPE 5 for further discussion on identifying, measuring, recording, and classifying impairment charges.

Prior to adopting ASC 842, Leases, lease termination costs were accounted for under ASC 420-10. With the adoption of ASC 842, the guidance in ASC 420-10 has been modified to remove leases from its scope. Refer to LG 4.4 for further details regarding the subsequent recognition and measurement of a lease and LG 5 for further details regarding modification and remeasurement of a lease. See PPE 4.2.5 for details regarding the subsequent accounting for right-of-use assets, PPE 5.2.6 for lease impairment considerations, and PPE 6.4.1.1 for a discussion of lease abandonments. See FSP 11.4.4.1 for a discussion of the presentation and disclosures of exit and disposal cost obligations.

When deliberating ASC 420-10, the FASB discussed whether a definition of restructuring should be developed, but believed an operational definition of restructuring for accounting purposes was not feasible. ASC 420-10 does, however, indicate that an exit activity includes, but is not limited to, a restructuring as defined in International Accounting Standard No. 37 (IAS 37), Provisions, Contingent Liabilities and Contingent Assets. As a result, costs associated with exit or disposal activities under ASC 420-10 include, but are not limited to: (1) involuntary employee termination benefits pursuant to one-time termination plans (i.e., other than pre- existing arrangements or a new plan that is expected to be ongoing, the accounting for which is addressed in ASC 710), (2) costs to terminate a contract that is not a lease, and (3) other exit costs.

IAS 37 defines restructuring as "a programme that is planned and controlled by management, and materially changes either: (a) the scope of a business undertaken by an entity; or (b) the manner in which that business is conducted." A restructuring covered by IAS 37 includes the sale or termination of a line of business, the closure of business activities in a particular location, the relocation of business activities from one location to another, changes in management structure, and a fundamental reorganization that affects the nature and focus of operations.

6.5 Disposal activities, exit costs, and restructuring charges - 6.5.1 Costs associated with exit or disposal activities

Publication date: 31 Jul 2020

ASC 420-10 incorporates many of the views of the SEC staff that were previously included in SAB 100. The issuance of SAB 103 in May 2003 resulted in the deletion of SAB 100 guidance previously included under SAB Topic 5.P.1 and SAB Topic 5.P.2. However, there continue to be specific areas and issues included in the previous guidance that provide additional insights beyond that in ASC 420-10 and have been included in the discussion that follows.

Certain costs that may be associated with exit or disposal activities are not included in the scope of ASC 420-10. Examples of these costs include:

  • Termination benefits that are provided to employees under the terms of an ongoing benefit arrangement (or enhancements to an ongoing benefit arrangement) or an individual deferred compensation contract covered by other accounting pronouncements. If termination benefits are offered in exchange for an employee's voluntary termination of service, the liability for such voluntary termination benefits should be recognized in accordance with ASC 712-10.

  • Costs to terminate a lease are to be accounted for in accordance with ASC 842-20 (after adoption of ASC 842). Costs to terminate a capital lease are to be accounted for in accordance with ASC 840-10 (prior to adoption of ASC 842).

  • Costs associated with the retirement of a long-lived asset are to be accounted for in accordance with ASC 410-20.

  • Impairment of long-lived assets and long-lived asset disposal groups are to be accounted for in accordance with ASC 360-10.

See BCG 2.5.15 for guidance with respect to the recognition of liabilities related to restructurings or exit costs in a business combination.

6.5 Disposal activities, exit costs, and restructuring charges - 6.5.1 Costs associated with exit or disposal activities - 6.5.1.1 Initial recognition of liabilities for exit/disposal activities

Publication date: 31 Jul 2020

ASC 420-10 incorporates the liability recognition concepts embodied in CON 6. Accordingly, a liability associated with an exit or disposal activity should be recognized only when an event has occurred that creates a present obligation to transfer assets or provide services in the future that meets the definition of a liability set forth in CON 6. ASC 420-10 emphasizes that the present obligation must be to others and result from the occurrence of a past event. In this regard, ASC 420-10 makes it clear that an entity's commitment to an exit plan, in and of itself, does not create a present obligation to others for the costs expected to be incurred under the plan. Under ASC 420-10, a liability for costs associated with an exit or disposal activity is incurred when the three characteristics of a liability cited in CON 6, par. 36 are present. Specifically, an entity must:

  • Have a "present duty or responsibility to one or more entities that entails settlement by probable future transfer, or the use of assets at a specified or determinable date, on occurrence of a specified event, or on demand". ("Probable" is used with its general meaning and not in the specific technical sense that it is used in ASC 450-10, Contingencies, Overall. Thus, it does not imply the same "high degree of expectation" that its use in ASC 450-10 implies.)

  • Have little or no discretion in avoiding a future transfer of assets or providing services

  • Determine that an obligating event has already happened

The requirement to recognize costs associated with exit or disposal activities at fair value differs from the probability notion in ASC 450-10. Using that criteria, a liability for costs associated with disposal activities would have been initially recognized when (1) the future transfer of assets or provision of services was probable (as that term is used in ASC 450-10), and (2) the amount could be reasonably estimated. However, as noted above, recognition of exit costs under ASC 420-10 is not based on the probable and reasonably estimable model. ASC 450-10 deals with uncertainty by using a probability threshold for recognition of a loss contingency. In the estimation of the fair value of a liability for exit costs under ASC 420-10, uncertainty in the amount and timing of the future cash flows necessary to settle a liability is addressed by incorporating that uncertainty in the measurement of the fair value of the liability following the principles of CON 7.

6.5 Disposal activities, exit costs, and restructuring charges - 6.5.1 Costs associated with exit or disposal activities - 6.5.1.2 Fair value of liabilities for exit/disposal activities

Publication date: 31 Jul 2020

ASC 420-10 requires that a liability for a cost that is associated with an exit or disposal activity be recognized at its fair value when incurred. That is, it should be recognized when the cost meets the definition of a liability (as set out in CON 6, par. 35). See the Fair value measurements guide for additional guidance on measuring the fair value of the liability.

6.5 Disposal activities, exit costs, and restructuring charges - 6.5.1 Costs associated with exit or disposal activities - 6.5.1.3 Subsequent accounting for exit/disposal activity accruals

Publication date: 31 Jul 2020

ASC 420-10 provides guidance regarding the subsequent accounting for liabilities associated with exit or disposal activities. Companies are required to subsequently adjust accruals established under ASC 420-10 for changes resulting from revisions to either the timing or the amount of estimated cash flows. That change should be measured using the credit-adjusted risk-free rate that was used to initially measure the liability. Accordingly, subsequent measurement of the liability is not at fair value. The adjustment should be recognized in the period of change and reported in the same line item as the original costs were classified at initial recognition.

ASC 420-10 also requires the liability to be adjusted due to the passage of time as an increase in the liability and as an expense (e.g., accretion expense). Interest on the liability would be accreted using the original effective rate, and recognized as an operating expense in the income statement (or statement of activities). This guidance is similar to that in ASC 410-20, Asset Retirement and Environmental Obligations, Asset Retirement Obligations.

6.5 Disposal activities, exit costs, and restructuring charges - 6.5.2 Employee termination costs

Publication date: 31 Jul 2020

ASC 420-10 addresses the accounting for involuntary employee termination costs that are provided pursuant to a one-time benefit arrangement. A one-time benefit arrangement is an arrangement established by a plan of termination that applies for a specified termination event or for a specified future period. For further details on employee termination costs, including one-time benefit arrangements, refer to PEB 8.5.

6.5 Disposal activities, exit costs, and restructuring charges - 6.5.3 Contract termination costs (after ASC 842)

Publication date: 31 Jul 2020

ASC 420-10 also applies to costs to terminate a contract that is not a lease and that existed prior to the entity's commitment to a plan of disposal. Contract termination costs that may be incurred in connection with an exit or disposal activity are (a) costs to terminate the contract before the end of its term or (b) costs that will continue to be incurred under the contract for its remaining term without economic benefit to the entity.

ASC 420-10 provides guidance related to the recognition and measurement of liabilities for lease and contract terminations. Costs to terminate a contract before the end of its term should be recognized and measured at their fair value when the entity terminates the contract in accordance with the contract terms. Costs that will continue to be incurred under a noncancelable contract should be recognized and measured at fair value when the entity ceases using the right conveyed by the contract (e.g., the right to receive future goods or services).

6.5 Disposal activities, exit costs, and restructuring charges - 6.5.3A Lease and other contract termination costs (prior to ASC 842)

Publication date: 31 Jul 2020

With the adoption of ASC 842, Leases, the guidance in ASC 420-10 was modified to remove leases from its scope. See the Leases guide and PPE 4.2.5 for further details on the accounting for leases after the adoption of ASC 842. See PPE 6.5.3 for details regarding the accounting for other contract termination costs after the adoption of ASC 842.   

Prior to adopting the new leases standard, lease termination costs were accounted for under ASC 420-10. The remainder of this section discusses the accounting prior to adoption of ASC 842.

ASC 420-10 also applies to costs to terminate an operating lease or other contract that existed prior to the entity's commitment to a plan of disposal. Circumstances in which there is a termination of an operating lease not involving a restructuring activity are also to be accounted for pursuant to ASC 420-10. Contract termination costs that may be incurred in connection with an exit or disposal activity are (a) costs to terminate the contract before the end of its term or (b) costs that will continue to be incurred under the contract for its remaining term without economic benefit to the entity (e.g., lease rental payments that will continue after an entity ceases to use the property).

ASC 420-10 provides guidance related to the recognition and measurement of liabilities for lease and contract terminations. Costs to terminate a contract before the end of its term should be recognized and measured at their fair value when the entity terminates the contract in accordance with the contract terms. Costs that will continue to be incurred under a noncancelable contract should be recognized and measured at fair value when the entity ceases using the right conveyed by the contract (e.g., the right to use a leased property or to receive future goods or services). When the contract is an operating lease that is terminated, a liability based on the remaining lease rental should be measured at its fair value when the entity ceases using the rights conveyed by the contract (the "cease-use" date) based on the remaining lease rentals, adjusted for the effects of any prepaid or deferred items recognized under the lease, and reduced by estimated sublease rentals that could be reasonably obtained for the property. Recording a liability at the cease-use date is only appropriate for the cease of use of functionally independent assets (i.e., the assets could be fully utilized by another party) when the lessee is permanently ceasing use. The liability for remaining rentals should be reduced by any estimated sublease rentals, net of direct costs incurred to obtain the sublease (but not reduced to an amount less than zero), regardless of whether the entity intends to enter into a sublease or whether the terms of the lease allow the lessee to sublease the asset. This is due to the fact that the lessor may be required by law to mitigate its damages, as is common in the US. However, ASC 420-10 limits the circumstances in which sublease rentals should reduce the liability by stating that entities must consider estimated sublease rentals only to the extent that they could reasonably be obtained for the property.

With respect to leases, a liability should be recognized at the cease-use date only if the terms of an operating lease are unfavorable relative to the terms of a new lease for similar property. This implies recognition of a liability only if the lease terms are not at prevailing market terms. When estimating the fair value of a liability for costs to terminate an operating lease, an issue arises regarding whether executory costs (that is, property taxes, insurance, maintenance costs) should be included as part of the fair value of the liability. Whether executory costs are considered costs required to be expensed as incurred under ASC 420-10 or costs of the lease termination is not normally relevant, as such costs are inherent in the terms of any lease or sublease and a third party lessee or sublessee would be required to assume them, either directly or indirectly, in connection with any lease or sublease of the property. Consequently, we believe it should be assumed that any obligation to pay executory costs in connection with the termination of an operating lease could be passed through to a subtenant on a sublease. Stated another way, payments for executory costs are generally at prevailing market prices and we would not expect these costs to increase the fair value of an exit liability. Therefore, they are not likely to be accrued at the cease use date. In addition, executory costs not directly related to the leased asset (e.g., personal property taxes or insurance on the lessee's assets located in the leased location) are not accruable as contract (lease) termination costs under ASC 420-10.

The FASB decided that ASC 420-10 would not be limited to lease termination costs and, as a result, the guidance in ASC 420-10 applies to all contract terminations. Accordingly, when an entity ceases using a property that is leased under an operating lease before the end of its term, the approach in ASC 420-10 contemplates that a liability should be recognized for lease termination costs when the leased property has no substantial future use or benefit to the lessee. Furthermore, ASC 420-10's "cease-use" date requires that the liability for all lease termination costs be recognized and measured when the rights provided for under the contract are no longer used by an entity in operations. This guidance, however, does not relate to the "impairment" of an operating lease or executory contract. The key point is that ASC 420-10 should not be analogized to losses on executory contracts. The SEC has stated that it is generally inappropriate to recognize impairments on executory contracts unless such losses are specifically prescribed in authoritative literature (e.g., a loss on a sub-lease arrangement not involving a disposal (ASC 840-20-25-15) or a firm commitment to purchase inventory that, when acquired, would be subject to an immediate lower of cost or market write-down (ASC 330-10)).

For further considerations of lease and other contract termination costs, see Question PPE 6-1, Question PPE 6-2, Question PPE 6-3, Question PPE 6-4, Question PPE 6-5, and Question PPE 6-6.

Question PPE 6-1 (prior to ASC 842)

An exit plan includes a reduction in the operations currently performed in a leased facility comprised of five floors. The lease is an operating lease, expiring three years from the date management commits to an exit plan and communicates the plan. At that date, all five floors are fully used in operations and will continue to be used for one year. When the exit plan is completed in one year, only three floors of the leased space will be used. The remaining two floors will be permanently idle. Assuming all other provisions of ASC 420-10 have been met, may the company recognize a liability at the communication date for the exit costs associated with the two floors of the building that will be permanently idle?

PwC response

No. As of the communication date, the company has not incurred a liability. Communication of a commitment to cease using two floors of the building in the future does not, in and of itself, create a current obligation of the company. Further, those floors continue to be used in operations for one year from the commitment date. Under ASC 420-10, contract termination costs that continue to be incurred under the contract for its remaining term without economic benefit to the entity can be recognized when the company ceases using the right conveyed by the contract. Accordingly, in year two, the company may be able to recognize the liability for costs associated with the permanently idle floors of the building, once the company ceases using those floors. In addition, the company must prove that the two floors of the building are functionally independent from the rest of the building (e.g., they have a separate entrance to the floor) and will not be used in operations (e.g., they are not being used as storage). The measurement is based on the fair value of the remaining lease rentals, reduced by estimated sublease rentals that could be reasonably obtained for the property.

Question PPE 6-2 (prior to ASC 842)

A lessee of commercial office space leases several floors of a multi-tenant office building. The lessee has ceased using certain floors and portions of other floors in the building. Should a liability for contract termination costs be recognized under ASC 420-10?

PwC response

A liability should be recognized under ASC 420-10 for the costs associated with one or more floors or portions of floors, provided they are functionally independent assets (i.e., they could be fully utilized by another party because, for example, they have separate entrances, access to restrooms, etc.) and the lessee intends to cease using them permanently. Usage would not be considered to cease permanently if the lessee intends to resume using the assets prior to the end of the lease term, the assets cannot be leased in its present condition, or the lessee has not determined whether it will resume using the assets at a loss. If usage is not considered to cease permanently and the lessee subleases the assets, ASC 840-20-25 would apply at the time the asset is subleased.

Notwithstanding the FASB's use of the term "operating lease or other contract," we believe that it did not intend to change the accounting based on whether a lessee leased a group of functionally independent assets in a single lease transaction or in a number of related lease transactions, all entered into at the same time. Accordingly, we believe the accounting should be the same for both situations. ASC 420-10 should be applied to the functionally independent assets on an asset-by-asset basis.

Question PPE 6-3 (prior to ASC 842)

If Company A ceases use of a leased building, should it calculate the fair value of the liability under ASC 420-10 by reducing the remaining lease rentals by the current fair market rental for equivalent space, assuming that the leased building could be subleased at the current fair market rental, regardless of whether the terms of the lease allow the lessee to sublease the asset?

PwC response

Yes. We believe that, even if the terms of the lease preclude the lessee from subleasing the building, potential sub-lease rentals should be considered in measuring the liability if the building could be re-leased by the lessor to another lessee during the remaining term of the lease and the lessor is legally required to mitigate the amount of damages in the event of lessee default, as is typical in the United States.

In determining the amount of sublease rentals that could be obtained for the building, we believe Company A should consider all of the relevant facts and circumstances. These would include, among others: (1) the length of the remaining term of the lease, (2) the cost to obtain one or more lessees or sublessees, including brokerage commissions and leasehold improvements that would be required, and (3) any other market or other external impediments to re-leasing or subleasing the property. Company A should not consider any internal or self-imposed impediments to subleasing, such as (1) precluding a competitor from being a sublessee candidate, or (2) deciding to forego the pursuit of sublease rentals in order to focus its efforts on its primary business. Company A should consider the current fair market rental for equivalent property and assess the ability to obtain sublease rentals for the specific property under lease within the context of the overall local real estate market. A liability should be recognized at the cease-use date only if the terms of an operating lease are unfavorable relative to the terms of a new lease for similar property.

An expected present value technique will often be the best measure to estimate the liability.

Question PPE 6-4 (prior to ASC 842)

On January 1, 20X6, Company A commits to a plan to exit a facility on June 30, 20X6. The facility is subject to an operating lease that Company A will continue to use until June 30, and will then sub-lease to an unrelated third party. The lease facility is part of a larger asset group, for which there is no impairment. Company A will meet the criteria within ASC 420 for recognizing a liability associated with the lease only when Company A reaches the cease-use date of June 30, 20X6. Payments received by Company A under the sublease will be less than the amount paid by Company A under the original lease and are believed to represent estimated sublease rentals that could be reasonably obtained for the property. Company A has $100 of leasehold improvements (net of accumulated amortization) associated with the leased building at January 1, 20X6, with four years of original useful life remaining. The fair value of the leasehold improvements is expected to be de minimus at the date of exit.

How should Company A account for their leasehold improvements?

PwC response

Company A should review its amortization estimates on January 1, 20X6, pursuant to ASC 250, and accelerate amortization over the revised remaining useful life of six months, through June 30, 20X6. Company A's plan to exit the building earlier than anticipated and enter into the sublease at a loss provides evidence that the useful life of the leasehold improvements is shorter than the remaining original life of four years.

Question PPE 6-5 (prior to ASC 842)

In 20X3, a company reached a decision to exit a leased facility. The company met the "cease-use" criteria in accordance with ASC 420-10, and properly recorded a liability based on the remaining lease rentals reduced by the estimated sub-lease rentals that could be reasonably obtained for the property. After the restructuring, the company executed a sub-lease for this space. In July 20X5, the company and the sub-lessee failed to renew the sub-lease agreement and the sublessee vacated the facility. At the same time, the company had positive news related to their business that would require additional physical capacity. In September 20X5, as part of their annual long-term strategic plan, company management and the Board decided they would no longer seek to sub-let the remaining space and instead use the remaining space for their own business needs. What criteria should the company use to evaluate when to reverse a restructuring accrual?

PwC response

ASC 420-10-40-1 makes it clear that a liability should be reversed if an event or circumstance occurs that discharges or removes an entity's responsibility to settle a liability for a cost associated with an exit or disposal activity recognized in a prior period. ASC 420-10, however, is not clear as to what criteria should be used to evaluate when the accrual should be reversed. We believe that the guidance provided in ASC 420-10 in determining when to recognize costs associated with exit or disposal activities should also be considered to determine when, if applicable, such a charge should be reversed.

The reversal of the exit activity is initiated when either (1) management, having the authority to approve the action, commits to a plan that utilizes the space or (2) management otherwise begins to use the space. Therefore, in this set of facts and circumstances, the liability would be reversed in September 20X5 once the Board approved the action to re-enter the space and could no longer assert the accrual for an exit activity was necessary.

Question PPE 6-6 (prior to ASC 842)

Company A leases three floors of office space over a ten year non-cancelable operating lease term. In year five, Company A decides to downsize its operations and vacate one of the floors. Each of the leased floors is considered functionally independent. On June 30, 20X1, approximately one month before vacating the floor, Company A enters into a sublease with an unrelated third party, whereby the floor Company A is planning to vacate is leased for a period of three years of the remaining five years of the head lease term. The sublease rent per square foot is less than the head lease rent per square foot paid by Company A, and the sublessee does not have any renewal options. On July 31, 20X1, Company A downsizes its operations and vacates the leased floor.

For the sublet space, should the Company account for the transaction as the termination of a contract under ASC 420, Exit or Disposal Cost Obligations, or as a loss on a sublease in accordance with ASC 840-20-25-15?

PwC response

Company A should first evaluate whether its sublease constitutes a permanent or temporary exit of the vacated floor. Consideration should be given to management's plans and intent for the two years remaining on the lease term after the end of the sublease. If management considers the exit to be temporary because management intends to reoccupy the space at some future date or has not made a decision to permanently exit the space, the threshold for applying ASC 420-10 for a contract termination is not met. Accordingly, ASC 840-20-25-15 would be applicable. Under ASC 840-20-25-15, at June 30, 20X1 (the date of the execution of the sublease), a loss on sublease would be recorded.

If management commits to exiting the space permanently, Company A should make an accounting policy election to either (a) record a liability upon execution of a sublease in accordance with ASC 840-20-25-15 or (b) record a liability upon its cease-use date in accordance with ASC 420-10. If Company A's policy is to account for the loss on a sublease in accordance with ASC 840-20-25-15, a liability should be recorded on June 30, 20X1 (the execution date of the sublease). The liability should be measured based on the three-year sublease period. On July 31, 20X1, when Company A ceases using the floor, ASC 420-10 applies and the liability would be adjusted to its fair value in accordance with ASC 420-10. The liability would be based on the remaining lease rentals, over the remaining five-year term of the head lease, reduced by actual or estimated sublease rentals at the cease-use date.

If, on the other hand, Company A's policy when permanently exiting a space is to follow ASC 420-10, a loss should not be recorded upon execution of a sublease. Company A would record a liability under ASC 420-10 for the termination of the contract on July 31, 20X1, the cease-use date. Under either accounting policy election, the liability balance under ASC 420-10 would be the same at July 31, 20X1.

The cease-use date is the date Company A physically vacates the space. Only when Company A executes a sublease on the same date it ceases using the space would the execution and cease-use dates coincide.

6.5 Disposal activities, exit costs, and restructuring charges - 6.5.4 Recording other costs related to exit/disposal activities

Publication date: 31 Jul 2020

ASC 420-10 also applies to other costs associated with an exit or disposal activity, including costs incurred for (1) protecting and maintaining an asset while held for sale, (2) plant closings, and (3) employee or facility relocations. Typically, these costs are not associated with, and will not be incurred to generate revenues following an entity's commitment to a plan, and are incremental to other costs incurred by the entity (i.e., the costs will be incurred as a direct result of that plan).

With respect to other exit costs, irrespective of the direct nature of these costs, ASC 420-10 requires that a liability for such costs only be recognized when they meet the definition of a liability in CON 6, rather than upon commitment to an exit or disposal plan. The primary basis for recognition lies in the present obligation to others based on a requisite past transaction or event. Accordingly, a company's intention, which is reflected in the commitment to a plan, does not in and of itself create a present obligation to others.

ASC 420-10 requires that other costs related to exit or disposal activities be accounted for at fair value (see PPE 6.5.1.2). In addition, ASC 420-10 provides guidance for the subsequent accounting for those costs (see PPE 6.5.1.3).

Although ASC 420-10 does not allow for costs associated with exit or disposal activities to be recognized until incurred, we believe that the criteria included in SAB 100 provide guidance in determining which costs are considered exit-related cost and can be presented and disclosed in the financial statements as restructuring costs. (Note that the term "commitment" (used in the SAB) has been replaced with the term "communication" in the list below, to comply with ASC 420-10.)

•  The cost is not associated with or is not incurred to generate revenues after the communication date, and either:

•  The cost is incremental to other costs incurred by the company prior to the communication date and will be incurred as a direct result of an exit plan; or

•  The cost represents amounts to be incurred under a contractual obligation that existed prior to the communication date and will either continue after the exit plan is completed with no economic benefit to the company or be a penalty incurred by the company to cancel the contractual obligation.

For further considerations of the accounting for other exit costs, see Question PPE 6-7, Question PPE 6-8, and Question PPE 6-9.

Question PPE 6-7 (prior to ASC 842)

If a company adopts a restructuring plan that calls for the consolidation of eight facilities into four facilities, can management accrue all costs of consolidating the facilities at the communication date under ASC 420-10?

PwC response

  • No. Only those costs for which the liability is incurred can be classified as exit costs and should be accrued at fair value at the communication date. For example, costs such as those associated with the relocation of people or equipment, with the disposal of equipment that has no value, or with closing a facility that is removed from operations, should not be accrued at the communication date. Costs associated with terminating a lease should be recognized and measured at its fair value at the cease-use date, or when the entity terminates the contract in accordance with the contract terms (e.g., when the entity explicitly gives written notice to the counterparty within the notification period specified by the contract, or has otherwise negotiated a termination with the counterparty).

Question PPE 6-8

A company operates 100 retail outlets and has identified the specific location of 60 out of 70 stores that it intends to close pursuant to a store consolidation plan. The exit plan for the 60 stores identifies all significant actions and related costs in budget line item detail. Management believes the average cost to close the additional 10 stores will approximate the average cost of closing the identified 60 stores. Assuming that all other provisions of ASC 420-10 have been met, may the company recognize a liability at the communication date for the exit costs and involuntary termination benefits associated with all 70 stores?

PwC response

No. While recognition of estimated exit costs and involuntary termination benefits for the 60 identified stores is appropriate, the requirements of ASC 420-10 have not been met for the remaining 10 stores.

If the company decides not to close one of the 60 stores in a period following it recognizing the liability, the related accrued exit costs and involuntary employee termination benefits for the one store must be reversed; the liability cannot be maintained in anticipation of the costs expected to be incurred when other stores are identified for closing.

Question PPE 6-9

A company enters into a long-term supply contract with a vendor for a component part previously produced internally. In connection with the contract, the company decides to close one of its plants that produced the component and the vendor agrees to reimburse all plant closing and employee severance costs. The vendor will not purchase any underlying plant assets and the company is not obligated to provide any separate services to or for the vendor such as marketing or advertising services. The vendor simply has agreed to reimburse the company for the costs associated with the closure of the plant as long as the company enters into a supply contract arrangement with the vendor. How should the company account for the vendor's reimbursement of its plant closing and severance costs?

PwC response

The vendor's reimbursement for plant closing and severance cost falls under the scope of ASC 705-20. Cash consideration received by a customer from a vendor is presumed to be a reduction of the prices of the vendor's products or services and should, therefore, be characterized as a reduction of cost of sales when recognized in the customer's income statement, unless the criteria in ASC 705-20-15-1 are met. The presumption could not be overcome in this circumstance as the vendor does not receive a distinct benefit (goods or services) in exchange for the consideration. Although there is agreement to reimburse the company for the costs, the reimbursement is for cost associated with the closure of the plant as long as the company enters into a supply contract arrangement with the vendor, not specifically for the sale of the vendor's products, as contemplated in ASC 705-20-25-1. The last criteria in ASC 705-20 is also not met, as the reimbursement is not for sales incentives offered to customers by manufacturers.

The company should separately assess the accounting for costs associated with the plant closure under applicable literature (e.g., ASC 420, ASC 712, ASC 715, ASC 450) and the vendor's reimbursement under ASC 705-20, and not as an offset to each other. The vendor's reimbursement should be treated as a reduction of cost of sales over the life of the supply contract entered into between the company and the vendor in this arrangement, as the nature of the incentive is for the company to continue in a supply agreement.

6.5 Disposal activities, exit costs, and restructuring charges - 6.5.5 Costs that do not qualify as exit costs under ASC 420-10

Publication date: 31 Jul 2020

Similar to costs that are associated with exit or disposal activities, other costs that are not part of these activities are only recognized as liabilities when incurred. Such costs that are not associated with the one-time termination benefits include, among others, repairs and maintenance, software development, moving, relocation, training (which is not part of a termination benefit), and hiring costs. Examples of costs that do not qualify as exit costs include:

  • costs to transition customers to a new product line or service;

  • franchisee incentive payments for equipment upgrades;

  • costs to modify executory contract arrangements (e.g., license and royalty arrangements, purchase or sales commitments, servicing arrangements); and

  • asset impairments for facilities that should follow the guidance in ASC 360-10.

These costs generally do not qualify as exit costs because they are generally incurred in order to benefit future periods. Accordingly, these costs should generally not be included in the presentation and disclosure of costs accounted for under ASC 420-10. As described in ASC 420-10-25-14 and ASC 420-10-25-15 and based on conversations with the SEC staff, employee relocation costs that are incremental and a direct result of an exit plan may be included in the presentation and disclosure of exit and other associated costs under ASC 420-10 if the inclusion of such costs is adequately disclosed (such costs must still be expensed as incurred pursuant to ASC 420-10-25-14 and ASC 420-10-25-15).

For further considerations regarding costs that do not qualify as exit costs, see Question PPE 6-10, Question PPE 6-11, Question PPE 6-12, Question PPE 6-13, and Question PPE 6-14.

Question PPE 6-10

As part of its plan to consolidate manufacturing plants, a company intends to hire 300 individuals for its new facility. The company normally has a good flow of applications to draw from when routinely hiring employees. However, due to time constraints associated with the opening of the new facility, the company has engaged a recruiting firm to assist in the hiring of employees. The company expects that its hiring costs will increase significantly and wants to accrue the incremental amount over its normal hiring costs as part of its restructuring charge. Do such costs qualify as exit costs that can be accrued in accordance with the provisions of ASC 420-10?

PwC response

No. Such costs are related to ongoing or future operations and, therefore, would not qualify as exit costs.

Question PPE 6-11

The company expects to hire 40 hourly people to replace employees who left the company for employment elsewhere when they learned that the facility would be shut down as part of a restructuring plan. The new hires will be responsible for the clerical processing of sales, accounts receivable, and accounts payable at the facility for six months until the facility is shut down. Can the payroll costs of the new hourly hires be accrued as part of a restructuring charge?

PwC response

No. Such costs are associated with the ongoing operations of the company and as such would not be accrued as part of the restructuring charge.

Question PPE 6-12 (prior to ASC 842)

Company A exited its corporate facility on March 31, 20X4 under the terms of its operating lease. The lease agreement requires Company A to return the facility to the lessor in its original leased condition (i.e., the condition of the property at the inception of the lease). There are no significant leasehold improvements added by Company A that need to be removed; however, certain repairs and maintenance activities are required, such as repairing minor damage, painting, and other clean-up activities. Under ASC 420-10, can Company A accrue the estimated costs of repairing the facility as of March 31, 20X4, given its obligation for these costs under the lease?

PwC response

No. Repairs and maintenance costs are not "contract termination costs" as defined by ASC 420-10-25-11. Rather, repairs and maintenance are considered "other associated costs" pursuant to ASC 420-10-25-14. Accordingly, a liability for such costs should be recognized and measured at its fair value in the period in which the liability is incurred, which is generally when the associated activities are performed, even if the costs are incremental to other operating costs and will be incurred as a direct result of a plan to exit. It should also be noted that repairs and maintenance costs are not included in the scope of ASC 420-10-15-3.

Question PPE 6-13 (prior to ASC 842)

Company X ceased operations at its Belgian manufacturing center. Certain assets with a remaining net book value of $350,000 used for production have been dismantled and are being shipped to Brazil where they will be installed in the company's Brazilian plant and used for production. Total cost to relocate this equipment is expected to be $1.5 million. Management expects to use the equipment for five years in Brazil. The total cost of moving the old equipment to Brazil is significantly less than what it would cost to buy new equipment and have it installed.

Should the costs to dismantle, transport, and reassemble the manufacturing equipment be capitalized?

PwC response

No. The costs to dismantle, transport, and reassemble the manufacturing equipment should be expensed as incurred. The costs are for moving the equipment; they do not extend the useful life of the equipment or improve the quantity or quality of goods produced by the equipment. Additionally, a proposed SOP, Accounting For Certain Costs and Activities Related to Property, Plant and Equipment, which was approved by FinRec in 2003 but not approved by FASB, addressed the accounting for dismantling, transportation, and reassembly costs. The view expressed in the SOP, while not authoritative, was that the costs described above should be expensed when incurred.

If some of the costs incurred increased the assets' useful life or increased the quantity or quality of units produced, a portion of those costs might be capitalizable and depreciated over the assets' remaining useful life.

Question PPE 6-14 (prior to ASC 842)

Company A operates in the on-line photo business. Company A offers a wide-range of services, including the cloud-based storage of digital pictures, printing hard copies of pictures and printing hard copy picture books for customers. Each of the product lines constitutes a separate division within the company. Company A has an agreement with a sole-source provider ("vendor") to provide the materials utilized in the company's business (e.g., paper, ink, cardboard). As an incentive for Company A, under the firmly committed supply agreement, the vendor agreed to provide significant discounts on the price of future purchases of paper and ink if Company A agreed to also purchase a minimum amount of cardboard every month. There is no termination clause that would allow Company A to buy out of the arrangement, or reduce the amount of cardboard to be purchased per month (i.e., the agreement is non-cancelable).

On January 1, 20X6, the Board of Directors, along with management, enters into a plan to restructure the business and exit the picture book creation business. The company intends to continue to purchase paper and ink from the vendor, but will discontinue the purchase of cardboard. However, according to the agreement, the company is still required to pay for a minimum amount of cardboard per month.

How should Company A account for the remaining contract charges for the minimum required purchases of cardboard?

PwC response

The noncancelable payments for the cardboard under the supply agreement do not constitute exit costs under ASC 420 and, therefore, should be excluded from the restructuring charge. Although Company A will continue to incur the costs of purchasing cardboard without taking delivery (i.e., no future benefit), the company will still receive the discounts on the purchase of paper and ink. The discount constitutes an economic benefit of the contract. As continued economic benefit is derived from the agreement, the costs related to the purchase of the monthly cardboard volumes should be reflected as a component of the costs of purchasing paper and ink on an ongoing basis and reflected in operating profit; if Company A includes a "restructuring" line item in its income statement, it should not include the costs related to the cardboard.

Since the payments to the vendor for the cardboard are made to obtain a discounted price on the paper and ink, a portion of those payments may be allocable to the inventory cost of paper and ink. The guidance in ASC 330 should be considered in determining what would be included as an inventoriable cost.

 
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