Welcome back. In this lesson, we'll go through a few examples of multiple elements in the accounting form. So, remember that nonlease elements within a lease are not recognized as right-of-use assets and lease obligations. Those could be services, it can be maintenance, it can be other goods, say if you have a printer contract which include the toner, you wouldn't include the trash for toner in there. You can see that sometimes with medical equipment with consumables, you're not going to include those in the lease payments, you're going to account for those as a separate element. The right-of-use asset is supposed to be purely for the use of a tangible asset. So here's an example. Devo Demolition leases a bulldozer, a truck, and a crane to Clark Engineers to be used in Clark's construction operations for the next three years. They also require the lessee to enter into a contract to maintain each piece of equipment. They're not going to leave it up to the lessee to do it, it's required to do it. So there's total consideration in the contract is 600,000 and it's payable in annual installments of 200,000. So quick analysis, there's potentially six elements here. You could have three separately lease elements and three related maintenance services. Why is equipment three separate elements? Well, if the equipment could be used on it's own without the other equipment, it would be a separate element. You only combine those elements if the answer you get is not materially different from the answer that you would get by accounting for them separately. But for this analysis, we're going to account for them separately. So both the lessor and the lessee are concluding that there are six elements because the machines are not highly interrelated and the lessee can benefit from each piece of equipment on it's own, and the $600,000 of consideration will be allocated to each of the elements, three pieces of equipment, three maintenance contracts. So we're going to assume that we have standalone prices available that can find other suppliers that provide equipment and maintenance services for similar equipment on a standalone basis. That way there'll be observable prices, we won't have to get into estimating prices or using a residual even though Devo Demolition doesn't offer them separately. So it's not necessary that the lessor offer those services separately to have a standalone price, we can look to the marketplace or we can estimate them using a couple of different methods that are provided for within the standard. So let's go assuming that we have standalone prices and do the calculation. So how do we allocate the total cost of this contract between the lease elements and the non lease elements such as the maintenance in this case? Well, in this problem we do have the standalone prices. They're not available from this lessor, but they are available from other providers within the marketplace. So I know how much it's going to cost to lease a bulldozer without maintenance and how much it would cost therefore with maintenance if I bought them separately. I'm going to sum those and then I'm going to take the percentage of each of the total price and I come up with a nice round figure of 80 and 20, I multiply that times the total payments within the contract. I'm going to allocate $480,000 to the lease element and $120,000 to the non-lease element, the maintenance. The next problem we then face is how do we allocate them to the individual pieces of equipment and to the individual maintenance contracts within the lease. Well, we're going to do that now by taking a percentage of each standalone price times this amount that we've allocated into the lease. Now, I've set that up in the spreadsheet already and the percentages are for the bulldozer 35.7, 21.4 for the truck, 42.9 for the crane, and I'm going to use and take this times that standalone price that I've allocated, I'm going to allocate the lease element and the non-lease element based on that percentage to each of these pieces of equipment in each maintenance contract. When I multiply that times the percentage times the 480,000, I'm allocating 171,000 to the bulldozer, 102,000 to the truck and 205,000 to the crane. In the maintenance contract, I'm allocating it the same way. So remember the important difference is going to be, this amount will be on the balance sheet discounted as we've already discussed. This amount will be considered an executory contract, it will not me on the balance sheet. This will continue to be an off-balance sheet item. So let's get back to our work. So first thing we did was allocate between the lease and non-lease elements, and we did that by taking the total in the standalone prices and multiplying by the ratio of the total rental payments so we can determine how much of it's going to leased and how much of it is non-lease. Then we multiply the ratio of the standalone prices of each lease element to the total standalone lease element prices. By the amount allocated to the lease elements, we did the same thing for the non-lease elements, so we took the percentage of the lease payment attributable to each piece of equipment and we did that in separate, use that amount to separate both the equipment and the service into separate elements. Now notice, recall that we did not use the exact same percentage for the truck lease and non-lease. The maintenance was different, was more expensive perhaps for some of the item such as a crane rather than a truck and we came up with a separate amounts part of which is going to be considered a service and will not be in the right-of-use asset and part of it that will be considered a lease element and will be recorded as a right-of-use asset in lease obligation. So the 480,000 allocated to the lease element is recorded as a lease obligation and related right-of-use assets. The 120,000 allocated to the non-lease elements is not recorded on the balance sheet. Non-lease elements are recognized as an expense when incurred. So this is going to increase the complexity of accounting for a lease considerably as operating leases, again, the lessee will have the option to include these costs all in a single element. They won't need to separate them out if they're willing to live with the fact that they'll have a higher lease obligations and right-of-use asset. The lessor does not have that option and he's going to have to separate them out in account for the lease element under the lease accounting auditor ASC842 and account for the service elements under the revenue recognition literature ASC606. Thank you.
