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Journal entry — FASB issues proposed ASU on additional narrow-scope improvements to the lessor accounting model in ASC 842

Published on: Aug 16, 2018

On August 13, 2018, the FASB issued a proposed Accounting Standards Update (ASU),1 which would provide lessors with additional narrow-scope improvements under ASC 8422 related to the following issues:3

  • Sales taxes and other similar taxes collected from lessees.
  • Certain lessor costs paid directly by lessees.
  • Recognition of variable payments for contracts with lease and nonlease components.

Sales Taxes and Other Similar Taxes Collected From Lessees

The proposed amendments would provide an accounting policy election that permits a lessor to “exclude from the consideration in the contract and from variable payments not included in the consideration in the contract all taxes assessed by a governmental authority that are both imposed on and concurrent with a specific lease revenue-producing transaction and collected by the lessor from a lessee.” As a result, when an entity elects this relief it would exclude any taxes collected that meet the scope from lease revenue presented. The proposed accounting policy election is similar to the policy election provided in ASC 606-10-32-2A for entities within the scope of the revenue guidance in ASC 606.

The proposed ASU includes a requirement for a lessor that makes this accounting policy election to disclose that fact.

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Connecting the Dots

By allowing a lessor relief similar to that provided for contracts within the scope of ASC 606, entities that engage in contracts that include both lease and nonlease elements should have a reduced burden. If finalized, this relief will allow an entity to make a similar election for all contracts within the scope of both ASC 606 and ASC 842.

Certain Lessor Costs Paid Directly by Lessees

The proposed ASU would require lessors to “exclude from variable payments lessor costs paid by a lessee directly to a third party when the amount of lessor costs paid by the lessee is not readily determinable by the lessor.” However, this requirement would not apply when the lessor pays the third party for the costs and then is subsequently reimbursed by the lessee, because such amounts are readily determinable by the lessor.

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Connecting the Dots

The proposed ASU would make this accounting treatment a requirement rather than an optional election, which is more consistent with the Basis for Conclusions of ASU 2016-08,4 on which this proposal is based (see Question 5 of the proposed ASU’s Questions for Respondents (reproduced below)). Also, the Board is proposing the use of the threshold “readily determinable” in the determination of when costs paid by a lessee meet the scope of the requirement to be excluded from a lessor’s revenue. The Board explains in paragraph BC18 of ASU 2016-08 the reasons for the use of this term (i.e., consistency with other assessments under ASC 842). In Question 6, the Board is indirectly asking for feedback on the use of this term with regard to the operability of the proposed amendment. We encourage affected entities to provide feedback to the Board on the proposed amendments as a whole, as well as on both of these matters.

Recognition of Variable Payments for Contracts With Lease and Nonlease Components

ASC 842-10-15-40 requires lessors to recognize variable payments “in profit or loss in the period when changes in the facts and circumstances on which the variable payment is based occur,” regardless of whether the variable payment relates to the lease or nonlease component in the contract. Stakeholders have observed that this guidance may result in the recognition of revenue by the lessor of a variable payment related to a nonlease component before the nonlease component is transferred to the customer. That is, ASC 842-10-15-40 read literally implies that as soon as an uncertainty that created variability in the consideration is resolved, that amount should be recognized as revenue regardless of whether the item to which it relates has been delivered to the customer/lessee. To clarify the paragraph’s intent, the proposed ASU would amend the guidance by requiring a lessor to allocate (as opposed to recognize) 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 as income in profit or loss in accordance with [ASC 842], while the amount of variable payments allocated to nonlease components [would] be recognized in accordance with other Topics (for example, Topic 606 . . .).”

Transition and Effective Date

The effective date and transition requirements of the proposed ASU would be consistent with those of ASU 2016-02.5 Upon considering stakeholder feedback on the proposed amendments, the FASB will determine the effective date and transition for entities that have early adopted ASU 2016-02.

Comments on the proposed ASU are due by September 12, 2018.

Questions for Respondents

The proposed ASU’s questions for respondents are reproduced below for reference.

Sales Taxes and Other Similar Taxes Collected From Lessees

Question 1: Should a lessor’s accounting for sales taxes and other similar taxes collected from lessees be aligned with Topic 606? If not, please explain why.

Question 2: Is the proposed accounting policy election, as written in this proposed Update, operable? If not, please explain why.

Question 3: Would the proposed accounting policy election result in a reduction of decision-useful information to users of a lessor’s financial statements? If so, please explain why.

Question 4: Should a lessor’s accounting policy election for sales taxes and other similar taxes collected from lessees be applied to new lease contracts only or to all existing and new lease contracts? Please explain your rationale.

Certain Lessor Costs Paid Directly by Lessees

Question 5: Should a lessor be required to exclude certain lessor costs paid directly by lessees to third parties on behalf of a lessor as variable payments when the uncertainty in the amount is not expected to ultimately be resolved? If not, please explain why.

Question 6: Are the proposed amendments for the accounting for certain lessor costs operable? If not, please explain why.

Question 7: Would the proposed requirement for a lessor to not report certain lessor costs paid directly by a lessee to a third party on behalf of the lessor result in a reduction of decision-useful information to users of a lessor’s financial statements? If so, please explain why.

Question 8: Should the proposed amendment in paragraph 842-10-15-40A to exclude certain lessor costs paid directly by lessees on behalf of a lessor as variable payments be applied to new lease contracts only or to all existing and new lease contracts? Please explain your rationale.

Recognition of Variable Payments for Contracts With Lease and Nonlease Components

Question 9: Would the proposed amendments clarify the application of paragraph 842-10-15-40? If not, please explain why.

Question 10: Are the proposed amendments for the accounting for certain variable payments for contracts with lease and nonlease components operable? If not, please explain why.

Transition and Effective Date for Early Adopters

Question 11: How much time would be needed to implement the amendments in this proposed Update for an entity that early adopts Update 2016-02 before these proposed amendments are finalized? What transition method and transition disclosures should those entities be required to apply (provide)? Please explain your reasoning.

Question 12: Should the effective date for the amendments in this proposed Update be aligned with that of Update 2016-02? If not, please explain why.

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1 FASB Proposed Accounting Standards Update, Leases (Topic 842): Narrow-Scope Improvements for Lessors.

2 For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s “Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”

3 At its meetings on March 28, 2018, and July 25, 2018, the FASB discussed the lessor issues identified herein, including relevant additional disclosure requirements. For a summary of the FASB’s discussions at those meetings, see Deloitte’s March 30, 2018, and July 27, 2018, journal entries.

4 FASB Accounting Standards Update No. 2016-08, Revenue From Contracts With Customers (Topic 606): Principal Versus Agent Considerations (Reporting Revenue Gross Versus Net).

5 FASB Accounting Standards Update No. 2016-02, Leases (ASC 842).

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