The Financial Accounting Standards Board (FASB) on Wednesday tentatively ruled to move forward with targeted improvements to its leases standard (Topic 842).
FASB staff will draft proposed standard updates (ASUs) for future vote on the following two issues:
Sales-type leases with variable lease payments (lessor only). Lessors should classify a lease with variable lease payments that do not depend on an index or a rate as an operating lease at commencement if 1) the lease would have been classified as a sales-type lease or a direct financing lease as defined in paragraphs 842-10-25-2 and 25-3 of the standard and 2) the lessor would have recognized a selling loss at commencement.
This decision was made to address an issue raised by stakeholders that existing guidance in Topic 842 for sales-type leases does not allow variable lease payments other than those that depend on a reference index or rate to be included in the lease receivable. The variable payments are recognized as lease income when they occur. As a result, the lease receivable may be less than the carrying amount of the related asset being derecognized, and the lessor recognizes a loss at lease commencement even if the lease is expected to be profitable over its term. The proposed update permits classification as an operating lease if the criteria are met so there is no derecognition of the leased asset and no Day 1 loss.
Lessors that have not yet adopted Topic 842 on or before fiscal years beginning after Dec. 15, 2021, would follow existing transition requirements in Topic 842. Lessors that have adopted Topic 842 for periods on or before those dates would have two options: They can either apply the amendments retrospectively to leases that begin or are modified on or after Topic 842 was adopted or prospectively to leases that begin or are modified on or after the date the amendments are applied. Early adoption would be permitted but not before adopting Topic 842.
Discount rate for lessees that are not public business entities. Topic 842 permits lessees that are not public business entities to make an accounting policy election to use a risk-free rate as the discount rate for all leases. FASB added a project to its technical agenda to amend this election. The Board decided:
- The election of the risk-free rate can be made by class of underlying asset, rather than at the entity-wide level, and the election (including asset class) must be disclosed.
- The risk-free rate in Topic 842 was retained, rather than other specified rates like corporate bond or prime rates, for the election.
- Lessees using the election are required to use the rate implicit in the lease when it is readily determinable, instead of the risk-free rate.
Lessees that have not yet adopted Topic 842 at the time a final ASU is issued would follow existing transition requirements in the standard. For lessees that have adopted Topic 842 at the time of a final ASU, the effective date of the amendments would be for annual reporting periods beginning after Dec. 15, 2021, and interim reporting periods beginning after Dec. 15, 2022, with early application permitted.
These lessees would be required to use a modified retrospective transition method. This requires remeasuring existing lease liabilities and right-of-use assets at the beginning of the period the ASU is adopted, calculated using the discount rate and remaining lease term at the adoption date, with a cumulative effect adjustment to retained earnings. There are no other remeasurements or reclassification of leases as a result of this amendment. The adoption of the new update and amount of the adjustment must be disclosed.