When the FASB issued ASU 2018-11, Leases (Topic 842), in July 2018, it was meant to reduce costs and ease the implementation of the leases standard. It provides a new transition method and a lessor practical expedient to not separate the lease and non-lease components of a contract if specific criteria are met. It also clarifies how to account for such combined component.
Previously, FASB ASC 842, required an initial adoption where lessees recognized lease assets and liabilities on the balance sheet for all leases with enhanced disclosures for all periods presented. In response to concerns about the costs and complexities involved with this ASC, ASU 2018-11 allows an entity to initially apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings during the period of adoption. Thus, the reporting for comparative periods will continue to be in accordance with FASB ASC 840, which requires that the ASC 840 disclosures remain the same for these periods.
FASB ASC 842 also requires lease components to be separated from non-lease components. Non-lease components would be accounted for in accordance with other applicable US GAAP, e.g. FASB ASC 606, Revenue from Contracts with Customers. Contract consideration should be allocated to the lease and non-lease components based on a relative standalone price. ASC 842 provided lessees with a practical expedient that does not require separation of the lease and non-lease components, but there is not one that was provided for lessors. ASU 2018-11 provides lessors with a practical expedient, by class of underlying asset, to not separate out the lease and non-lease components, but to account for it as a single component if the non-lease components would otherwise be accounted for under the new revenue guidance (ASC 606), and both of the following are met:
The timing and pattern of transfer of the non-lease components and associated lease component are the same
The lease component, if accounted for separately, would be classified as an operating lease
An entity electing this practical expedient is required to disclose certain information, by class of underlying asset as detailed in ASU 2018-11.
The effective date for entities that have not adopted ASC 842 is effective for FYE beginning after December 15, 2018 for public business entities and for certain not for profit entities. For all other entities, the effective date is for FYE beginning after December 15, 2019.
Proposed Impact of ASU 2018-260 on Lease Accounting
This proposed ASU was a response to make improvements to ASC 842, Leases, on lessor accounting requirements on 1) sales taxes collected from lessees, 2) lessor costs paid by lessees, and 3) variable payments for contracts containing both lease and non-lease components. A summary of each is below:
Sales Taxes Collected from Lessees
It allows lessors an accounting policy election, to exclude from contract consideration and variable payments not included in the contract, governmental taxes assessed. Lessors would not have to analyze sales taxes and other similar taxes on a jurisdiction by jurisdiction basis, in determining whether such taxes are the lessor’s primary obligation as the owner of the underlying assets being lease or are being collected by the lessor on behalf of third parties. Taxes assessed on a lessor’s total gross receipts or on the lessor as the owner of the underlying asset would be excluded from the scope of the accounting policy election. As proposed, the lessor could account for such taxes as if they are costs of the lessee and exclude them from lease revenue.
Certain Lessor Costs Paid Directly by Lessees
Lessor costs directly paid by lessees to third parties on behalf of the lessor are required to be excluded from variable payments when these amounts are not readily determinable by the lessor. It allows lessors an accounting policy election, to exclude from contract consideration and variable payments not included.
Recognition of Variable Payments for Contracts with Lease and Non-Lease Components
A lessor would need to allocate (rather than recognize as revenue) certain variable payments to the lease and non-lease components when the changes in facts and circumstances on which the variable payments are based occur. The basis would be the same as 1) initial allocation of the contract consideration or 2) most recent modification not accounted for as a separate contract. Variable payments allocated to the lease component would be recognized as income in profit or loss as required under ASC 842. Variable payments allocated to the non-lease components would be recognized in accordance with other applicable US GAAP, such as ASC 606.