ASC 842 for Long-Term Care: Master Leases and Resident Agreements

ASC 842 reaches a long-term care operator from two directions. As a lessee, the operator books a lease liability and right-of-use asset for the buildings it rents. Often one master lease covers several of them.

As a lessor, it has to decide whether each resident agreement contains a lease of the unit. That second question can end in ASC 606, through a practical expedient with strict conditions.

This page is for skilled nursing, assisted living, memory care and independent living operators. Each rents its buildings from a real estate owner. For the wider healthcare picture, start with healthcare lease accounting under ASC 842.

How is a senior living master lease split into lease components?

A master lease is one contract with one rent stream for several buildings. ASC 842 does not treat it as one asset.

Each building usually counts as its own lease component. ASC 842-10-15-28 makes each right of use a separate lease component when two criteria are met. First, the lessee can benefit from it on its own or with readily available resources. Second, it is not highly dependent on, or highly interrelated with, the other rights of use in the contract.

Separate buildings in separate towns usually pass both tests. Each one runs on its own. Losing one does not change how the others work.

So the operator often ends up with one lease component per building. The contract stays whole in law, but the books split it.

Land comes next, because the books must treat it apart from the building unless the effect is insignificant. ASC 842-10-15-29 makes the right to use land a separate lease component unless the accounting effect would be insignificant. It gives two examples: a split that would not change any component's classification, or a land component whose amount would be insignificant.

When land and building would both be operating leases, the split often changes nothing on the books, because the classification and the straight-line expense pattern are the same. Document the conclusion either way.

Then the rent is split, in proportion to what each piece would rent for on its own. ASC 842-10-15-33 has the lessee allocate the consideration on a relative standalone price basis. It uses observable prices where they exist and estimates where they do not.

Where no observable price exists, an appraisal of each building's market rent is one way to estimate it while maximizing observable information (ASC 842-10-15-33(a)). The same logic appears in lease components in a single lease contract.

What goes in the lease liability for a nursing home under ASC 842?

The lease liability is today's value of the rent still to be paid. ASC 842-20-30-1 measures the lease liability at the present value of the lease payments not yet paid. ASC 842-10-30-5 lists what counts as a lease payment. Four terms of a typical building lease set the number.

Fixed annual escalators

A fixed escalator, such as 2.5% a year, is a fixed payment under ASC 842-10-30-5(a). Every future step-up is known on day one, so all of it goes into the liability. On an operating lease, the total is then expensed on a straight-line basis under ASC 842-20-25-6(a).

Consumer price index (CPI) escalators

An escalator tied to the consumer price index (CPI) works another way. ASC 842-10-30-5(b) measures payments that depend on an index "using the index or rate at the commencement date." You do not guess at future inflation. Later CPI increases are variable lease payments, expensed in the period incurred under ASC 842-20-25-6(b).

The liability catches up only when something else forces a remeasurement. A change to the lease or to its term would do it. ASC 842-10-35-5 then updates the index to the date of that reassessment. See accounting for future CPI increases for the mechanics.

Triple-net taxes and insurance

Under a triple-net lease, the operator pays the landlord's property tax and building insurance. ASC 842-10-15-30(b) says paying the lessor's costs is not a component of the contract. So the question is whether the amount is fixed or not.

The Codification's own Example 12 shows both cases (ASC 842-10-55-141 to 55-143). When the tax and insurance move with the landlord's bills, they are variable lease payments. They stay out of the liability. When the contract fixes them, they are lease payments for the building and go in.

For insurance, this applies when the landlord is the primary beneficiary, for example the named insured. Insurance that protects the operator is the operator's own cost and sits outside lease accounting (KPMG Handbook: Leases, Question 4.2.40).

Renewal options

Building leases often carry long renewal options. ASC 842-10-30-1 includes a renewal period the lessee controls only if the lessee is reasonably certain to exercise it. A renewal the landlord controls is always included.

ASC 842-10-55-26 weighs all relevant economic factors: contract-based, asset-based, market-based and entity-based. Large improvements and the cost of moving residents belong in that file.

Are these building leases operating or finance leases?

ASC 842-10-25-2 sets five tests for a finance lease. Meet any one and the lease is a finance lease:

• Ownership transfers to the lessee by the end of the term.
• The lessee is reasonably certain to exercise a purchase option.
• The term is a major part of the asset's remaining economic life.
• The present value of the payments, plus any residual value the lessee guarantees, equals or exceeds substantially all of the asset's fair value.
• The asset is so specialized that it is expected to have no alternative use to the lessor at the end of the lease term.

Many leases from a real estate owner meet none of them. Title stays with the owner, and the buildings last a long time. Rent is priced as a return on the owner's money, not as a way to buy the building. That is a typical outcome, not a rule.

A purchase option or a very long term with renewals can change it. Run the tests on each component.

Worked example: one master lease, two facilities

Here is a simple master lease with every input stated. The operator leases a skilled nursing facility (Facility A) and an assisted living community (Facility B) from one landlord.

• Term: 15 years, no renewal reasonably certain, no purchase option.
• Rent: $3,600,000 in year one, paid annually in arrears, rising 2.5% a year (fixed). Annual payments keep the arithmetic simple; real master leases usually pay monthly.
• Taxes and insurance: reimbursed at actual cost, so variable and outside the liability.
• Discount rate: 7.0% incremental borrowing rate. A lessee that is not a public business entity may instead elect a risk-free rate for a class of underlying asset (ASC 842-20-30-3).
• Standalone basis: appraised market rent of $2,100,000 for A and $1,400,000 for B, $3,500,000 together.
• Assumed: both facilities are separate lease components and separating land has no effect. Both are assumed to classify as operating; the example gives no fair value, so the tests are not run.

The relative standalone shares are 60% for A ($2,100,000 ÷ $3,500,000) and 40% for B. The rent is split on those shares. Both have the same escalator. So each one's present value is the same share of the whole.

Each opening liability is the present value of 15 payments. They start at that building's year-one rent and grow 2.5% a year. The two building liabilities add to one cent more than the total. That cent is rounding.

With no initial direct costs, prepaid rent or incentives, each right-of-use asset equals its opening liability under ASC 842-20-30-5.

The liability after the first payment is the opening liability plus a year of interest, less the payment. For the master lease: $38,005,607.54 + $2,660,392.53 − $3,600,000.00 = $37,066,000.07.

The straight-line cost is total rent divided by 15 years. It is more than year-one rent because the higher later years are averaged in.

Here are the master lease entries, using the table's figures. Facility A and Facility B book their 60% and 40% shares.

The liability falls by the payment less the interest: $3,600,000.00 − $2,660,392.53 = $939,607.47. The right-of-use asset falls by the lease cost less the interest: $4,303,662.40 − $2,660,392.53 = $1,643,269.87. Debits and credits each total $5,243,269.87.

After year one, the right-of-use asset is $36,362,337.67. It runs below the $37,066,000.07 liability by $703,662.40. That gap is the accrued lease payments, the cumulative excess of straight-line cost over cash rent.

ASC 842-20-35-3(b) measures the right-of-use asset as the liability adjusted for them. The gap reverses in later years, when rent climbs above the straight-line cost.

What happens when the operator and landlord restructure the rent?

A negotiated rent cut or deferral, or taking a building out of the master lease, changes the contract. A concession the operator already had an enforceable right to may not.

ASC 842-10-25-8 treats a modification as a separate contract only when two things hold. It grants an additional right of use. And the extra rent is commensurate with that right's standalone price.

A rent cut adds no right of use. So it is not a separate contract.

Instead, ASC 842-10-25-9 reassesses classification at the modification's effective date. ASC 842-10-25-11 then reallocates the remaining consideration and remeasures the liability at a discount rate set on that date. Removing a building is a partial termination, and ASC 842-10-25-13 can produce a gain or loss. See ASC 842 modifications and remeasurement for the full sequence.

Are resident agreements leases under ASC 842?

Now flip to the lessor side. ASC 842-10-15-3 says a contract contains a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. A resident agreement for an independent or assisted living unit can meet that test. The resident pays for a specific apartment, plus meals, care and other services.

Suppose the operator can move a resident to another unit at any time during the stay. If it can practically do so and would benefit economically, that right is substantive. The resident then does not control an identified asset (ASC 842-10-15-10). A right to move a resident only when a specified event occurs, such as a change in care needs, does not count (ASC 842-10-15-13).

If it does contain a lease, ASC 842-10-15-31 would normally separate the unit's lease from the services. ASC 842-10-15-42A offers a lessor practical expedient instead. It is an accounting policy election by class of underlying asset. It applies only to nonlease components that would otherwise be accounted for under ASC 606, and only if both of these conditions hold:

• The timing and pattern of transfer for the lease component and the associated nonlease components are the same.
• The lease component, if accounted for separately, would be classified as an operating lease.

When the expedient applies, ASC 842-10-15-42B decides which standard governs the combined component. If the nonlease components predominate, it is accounted for under ASC 606 as a single performance obligation. Otherwise it is an operating lease under ASC 842. The test is whether the resident "would be reasonably expected to ascribe more value" to the services than to the unit.

Two limits apply. ASC 842-10-15-42C keeps the combined treatment to services that meet the timing condition; any that do not are separated. And entrance-fee contracts at continuing care retirement communities raise more ASC 606 questions, which this page does not cover.

For a lease hidden inside a service arrangement, see how to identify embedded leases in healthcare.

Frequently asked questions

Do senior living operators record their leased buildings on the balance sheet under ASC 842?

Yes. ASC 842-20-25-1 requires a lessee to recognize a lease liability and a right-of-use asset at commencement, for operating and finance leases alike.

How does a CPI rent escalator affect the lease liability?

ASC 842-10-30-5(b) measures index-based payments using the index at commencement. Later CPI increases are variable lease payments, expensed when incurred. They reach the liability only when another remeasurement event occurs, under ASC 842-10-35-5.

Are property taxes and insurance paid under a triple-net lease part of the lease liability?

Only when they are fixed. Under ASC 842-10-15-30(b) they are not separate components. Fixed amounts are lease payments in the liability. Amounts that vary with the landlord's bills are variable lease payments, expensed as incurred.

Can an operator account for a resident agreement under ASC 606 instead of ASC 842?

Yes, if it elects the lessor practical expedient in ASC 842-10-15-42A, the services would otherwise fall under ASC 606, both conditions are met, and the services are the predominant component. ASC 842-10-15-42B then requires the combined component to be accounted for under ASC 606.

Sources and further reading

• ASC 842-10-15-3, 15-4, 15-9, 15-10 and 15-13: the definition of a lease, the control test, the identified asset and substitution rights.
• ASC 842-10-15-28 to 15-31: separate lease components, the land component, and items that are not components.
• ASC 842-10-15-33: lessee allocation on a relative standalone price basis.
• ASC 842-10-15-42A to 15-42C: the lessor practical expedient not to separate nonlease components.
• ASC 842-10-25-2: lease classification criteria.
• ASC 842-10-25-8 to 25-13: lease modifications.
• ASC 842-10-30-1, 30-5 and 55-26: lease term, lease payments and the reasonably certain assessment.
• ASC 842-10-35-5: remeasuring index-based payments.
• ASC 842-10-55-141 to 55-143: Example 12, payments for taxes and insurance.
• ASC 842-20-25-1, 25-6, 30-1, 30-3, 30-5 and 35-3: recognition, operating lease cost, initial measurement, the risk-free rate election and the right-of-use asset after commencement.
• KPMG Handbook: Leases. Chapter 4 covers separating components and the lessor practical expedient (paragraphs 4.4.51 to 4.4.56). Question 4.2.40 covers insurance paid under a lease. Question 6.7.07 covers rent concessions.
• Deloitte Roadmap: Leases: components, lease payments and modifications.
• Related: ASC 842 variable lease payments and lessee vs lessor.

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