FASB Finalizes Updates to New Lease Standard
Joseph Jalbert, Audit Principal
In July 2018, the Financial Accounting Standards Board (FASB) issued back-to-back updates to the new lease guidance in Accounting Standards Codification Topic 842, Leases. Accounting Standards Update (ASU) 2018-10 was issued in order to clarify how to apply certain aspects of Topic 842, while right on its heels, ASU 2018-11 was issued with the primary objective of providing transition relief to entities in the year of adoption. Both of these updates have the same effective date as Topic 842. (As a friendly reminder, the new lease standard becomes effective on January 1, 2019 for public business entities with calendar year-end reporting dates and January 1, 2020 for non-public business entities with calendar year-end reporting dates.)
As one who likes to lead with the best (and, as you’ll see, more succinct) news, I’ll discuss these updates in reverse chronological order.
What a Relief!
In response to stakeholder concerns about the unanticipated costs and complexities of applying the provisions of the new lease standard as of the earliest comparative period presented, ASU 2018-11 provides entities with an option to apply the guidance as of the date of adoption. In other words, entities that elect this option will recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. For any comparative periods presented, entities will continue to follow the reporting and disclosure requirements under the current lease guidance in Topic 840.
Although this transition option simplifies implementation of the new standard, it’s worth reiterating that the effective date of the standard remains unchanged; therefore, institutions that are party to lease contracts that fall under the new guidance should continue with their current timeline towards implementation.
ASU 2018-11 also comes with an optional practical expedient for lessors due to concerns raised by stakeholders about the difficulty of determining standalone selling prices for lease and non-lease components that aren’t sold separately. Lessors may now elect to not separate non-lease components from lease components if the non-lease components otherwise would be accounted for under the new revenue recognition standard (Topic 606) and both (1) the pattern and transfer are the same for the non-lease components and associated lease components and (2) the lease components, if accounted for separately, would be classified as an operating lease. If the non-lease components are determined to be the predominant components of the contract, lessors should account for the combined components under Topic 606; otherwise, the combined components are to be accounted for under Topic 842. Judgment will need to be applied in determining the predominant component (i.e. lease or non-lease).
Only Sixteen You Say?
In order to address questions from stakeholders as to how to apply certain aspects of Topic 842, the FASB issued sixteen narrow amendments through ASU 2018-10 with the objective of clarifying application of various facets of the new standard. The amendments, summarized in the following massive table, are not expected to have a significant impact on current accounting practice or create a significant administrative cost for most institutions; nevertheless, it is important for institutions to be aware of these amendments and apply them based on their own facts and circumstances.
|Topic||Summary of Amendments|
|Residual value guarantees||Corrects a reference in ASC 460, Guarantees, to Topic 842 about a seller-lessee’s guarantee of the underlying asset’s residual value in a sale and leaseback transaction|
|Rate implicit in the lease||Clarifies that when a lessor calculates the rate implicit in a lease to be less than zero, the lessor should use zero as the rate implicit in the lease|
|Lessee reassessment of lease classification||Clarifies how an entity should perform a lease classification assessment, i.e., based on the facts and circumstances, and the modified terms and conditions (if applicable), as of the date the reassessment is required|
|Lessor reassessment of lease term and purchase option||Clarifies that a lessor should account for a lessee’s exercise of an option to extend or terminate the lease, or to purchase the underlying asset, as a lease modification unless the exercise of that option by the lessee is consistent with the assumptions that the lessor made at the commencement date of the lease|
|Variable lease payments that depend on an index or a rate||Clarifies that a change in a reference index or rate (e.g. the Consumer Price Index) upon which some or all of the variable lease payments in the contract are based does not constitute the resolution of a contingency. Therefore, variable lease payments that depend on an index or a rate should be remeasured, using the index or rate at the remeasurement date, only when the lease payments are remeasured for another reason|
|Investment tax credits||Clarifies the effect of investment tax credits on lease classification and better aligns with how investment tax credits are considered when determining the rate implicit in the lease|
|Lease term and purchase option||Clarifies that the period covered by a lessor-only option to terminate a lease is included in the lease term|
|Transition guidance for amounts previously recognized in business combinations||Clarifies the intent of the transition guidance provided to lessors for assets or liabilities recognized in accordance with Topic 805, Business Combinations, for favorable or unfavorable terms of an operating lease acquired as part of a business combination|
|Certain transition adjustments||Clarifies whether to recognize a transition adjustment through earnings rather than through equity when an entity initially applies Topic 842 retrospectively to each prior reporting period|
|Transition guidance for leases previously classified as capital leases under Topic 840||Corrects a reference in the transition guidance about subsequent measurements of the lease before the effective date of Topic 842|
|Transition guidance for modifications to leases previously classified as direct financing or sales-type leases under Topic 840||Clarifies that the transition guidance should be applied based on how the lease is classified before the modification|
|Transition guidance for sale and leaseback transactions||Clarifies that the transition guidance on sale and leaseback transactions should be applied to all sale and leaseback transactions occurring prior to the effective date|
|Impairment of net investment in the lease||Clarifies that a lessor must evaluate the net investment in the lease using cash flows expected to be received from both the lease receivable and the unguaranteed residual asset during the remaining lease term and after it ends|
|Unguaranteed residual asset||Clarifies that a lessor should not continue to accrete the unguaranteed residual asset to its estimated value over the remaining term of the lease if the lessor sells substantially all of the lease receivables associated with a direct financing lease or a sales-type lease|
|Effect of initial direct costs on rate implicit in the lease||Clarifies the effect that initial direct costs have on the determination of the rate implicit in the lease for a lessor’s purposes of classifying a lease|
|Failed sale and leaseback transaction||Clarifies that a seller-lessee in a failed sale and leaseback transaction adjusts the interest rate on its financial liability as necessary in order to make sure that the interest on the financial liability does not exceed the total payments (rather than the principal payments) on the financial liability|
This Just In
As of the publication of this article, the FASB issued a proposed ASU that will be out for comment until September 12, 2018 that includes additional amendments to Topic 842. Amendments under the proposed ASU include:
- Sales taxes and other similar taxes collected from lessees. The guidance would permit lessors, as an accounting policy election, to not evaluate whether such taxes are costs of the lessor or costs of the lessee; rather, the lessor would account for such taxes as costs of the lessee and exclude the amounts from lease revenue and the associated expense.
- Certain lessor costs paid directly by lessees. The guidance would require lessors to not report lessor costs paid by lessees directly to third parties on behalf of the lessor when certain conditions are met.
- Recognition of variable payments for contracts with lease and nonlease components. The guidance would require lessors to allocate (rather than recognize as currently required in Topic 842) certain variable payments to the lease and nonlease components when the changes in facts and circumstances on which the variable payment is based occur. After the allocation, the amount of variable payments allocated to the lease component would be recognized in accordance with Topic 842, while the amount allocated to nonlease components would be recognized in accordance with other accounting guidance, such as the new revenue recognition guidance in Topic 606.
More to Come?
It’s clear that as financial statement preparers have begun to dig into and apply the new lease guidance in Topic 842 that additional clarification is necessary in some instances. While the ASUs and proposed ASU discussed above result in a number of amendments to the new lease standard, there could very well be additional changes coming. If that’s the case, we’ll be sure to keep you updated.
If you would like to discuss these matters further, contact Joe Jalbert or your BNN advisor at 1.800.244.7444.
Disclaimer of Liability: This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.