Proposed amendments to the leases standard address preparer concerns with how the underlying economics for certain transactions was reflected.
The FASB has proposed amendments to the leases standard to address preparer concerns with how the underlying economics for certain transactions are reflected and the implementation cost and complexity. The exposure draft (a) addresses loss recognition at lease commencement for certain sales-type leases, (b) provides lessees an option to remeasure their lease liability, and (c) exempts entities from applying modification accounting upon certain amendments.
On October 20, 2020, the FASB issued an exposure draft that proposes amendments to ASC 842, Leases, as follows:
Loss recognition for sales-type lease with variable lease payments
Lessors would classify and account for a lease with predominantly variable lease payments that do not depend on an index or rate as an operating lease instead of a sales-type lease and recognize income from variable lease payments in the period earned.
Under ASC 842, since variable lease payments are recognized as income by a lessor only in the period earned, an otherwise profitable sales-type lease with significant variable lease payments results in the lessor recognizing a loss at lease commencement. The FASB’s proposal will obviate the need to recognize such loss at commencement, which will better reflect the underlying economics of the transaction.
Lessees would have an entity-wide accounting policy election to remeasure a lease liability prospectively at the date a change in a rate or index on which future lease payments are based takes effect.
ASC 842 requires a lessee to record any change in future lease payments due to changes in an index or rate only in the period incurred as a variable lease cost. IFRS 16, Leases, requires a lessee to remeasure the lease liability prospectively when a change in a rate or index on which future lease payments are based takes effect. Dual reporting entities find this difference between US GAAP and IFRS to be costly and complex to implement. The FASB’s proposal will allow flexibility to choose the most cost-effective accounting policy.
Lessors and lessees would be exempt from applying modification accounting to an amendment in the lease contract that early terminates the lease of an individual leased asset or component but does not economically impact the remaining leased assets or components in the same contract.
If a lease contract that provides a lessee the right to use multiple assets (e.g., master lease agreement) or multiple lease components (e.g., floors in an office building) is modified such that some of those rights are early terminated, ASC 842 requires a reporting entity to reclassify and remeasure the remaining leased assets or lease components prospectively using the modification date’s assumptions (e.g., economic life, fair value, discount rate). Lessees and lessors have found this burdensome and costly to implement. It can also change the classification and prospective accounting for the remaining leased assets or lease components even if they were not economically impacted. The FASB’s proposal will address these issues.
The solutions proposed by the FASB will impact the pattern and timing of revenue and cost recognition of affected preparers and will make implementation less costly and complex.
Comments on the exposure draft are due by December 4, 2020. We expect a final Accounting Standard Update early next year. The FASB will finalize the effective date for public and nonpublic companies after considering feedback received. The exposure draft proposes allowing early application by those preparers who have already adopted ASC 842.