Changes to the New Lease Accounting Standard: FASB Provides Updates
A version of this article appeared on Equipment Finance Advisor.
In February, the Financial Accounting Standards Board (FASB) provided updates related to its October 2020 Targeted Improvements Exposure Draft. Changes originally proposed in the draft were part of the FASB’s continued post-implementation review of ASC 842, the new lease accounting standard.
The guidance contained three proposed accounting changes that would:
- impact the recognition of revenue and cost;
- better align Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS); and
- reduce cost and complexity.
Feedback submitted by stakeholders through early December 2020 was considered by the FASB to determine which amendments would be made to the lease accounting standard. Here’s what companies should know about the latest decisions impacting lease accounting standards, with considerations for related transitions.
In February, after considering stakeholder feedback, the FASB issued amendment-related decisions that will impact the new ASC 842 lease accounting standard.
Proposed Change 1: Operating lease classification for lessors
The current standard requires lessors to exclude variable lease payments (e.g., payments based on equipment hours or units produced) when classifying and accounting for a sales type lease. The exclusion of variable lease payments from upfront recognition may lead to an initial loss on a contract with overall positive margins. Under the proposal, lessors are required to classify leases with variable lease payments not dependent on a rate as an operating lease.
- Update: The FASB is considering amending the proposed standard to “require lessors to classify and account for a lease as an operating lease if a lessor (a) meets any of the criteria for sales-type lease classification (in paragraph 842-10-25-2) and (b) would recognize a selling loss at lease commencement as a direct result of variable lease payments that do not depend on an index or a rate.”
Proposed Change 2: Remeasuring lease liabilities due to a change in payment escalation rate/index
The current guidance does not allow lease liabilities to be remeasured as a result of a change in rate or index (e.g., rent escalations based on Consumer Price Index) used to calculate lease payments. The proposed guidance would better align U.S. GAAP with IFRS by allowing for lease liabilities to be remeasured for a change to the rate used for variable lease payments. Entity-wide application is required, however, if remeasurement due to a change in rate is elected.
- Update: The FASB elected to remove this proposed amendment from its technical agenda.
Proposed Change 3: Contract modification due to partial termination
Under the current standard, a partial termination of a lease contract triggers a lease modification for all components. The proposal provides an exemption from applying lease modification guidance to all lease components when only one or more lease components are terminated. For example, a modification of a railcar lease to reduce the number of railcars would not require application of modification guidance to the remaining railcars. This exemption can be applied only if the termination of the separate lease components does not economically impact the remaining components.
- Update: The FASB elected not to finalize this amendment as additional contract modification improvements were identified in the comment letters. These improvements will be reviewed and considered for incorporation into the current proposed amendments.
Transition guidance will vary depending on whether an entity has adopted ASC 842 at the effective date of these proposed changes. If an entity has not adopted the new standard, then it will transition according to the guidance within ASC 842. If adoption has already occurred, the entity can elect to apply the changes retrospectively to the date of ASC 842 adoption or prospectively to leases that commence or are modified on or after the effective date of these proposed changes. Transition elections can be made on a per issue or topic basis.