When a lessor begins to have doubts about whether it will receive timely payments from lessees, the accounting gets puzzling.
That’s what prompted staff to issue some recent guidance around the new lease rules in Accounting Standards Codification Topic 842, telling companies they have some options about how to report indications that leaseholders may fall behind on lease payments.
That may, in turn, lead to differences in how companies report questionable operating lease receivables. “The FASB has decided to accept some diversity on this,” says James Barker, senior consultation partner at Deloitte & Touche.
Historically, if a company began to doubt whether it might collect all of the receivables on its balance sheet connected to leases, it generally turned to guidance on reporting credit impairments and loss contingencies. The rules on credit impairments are shifting, however, as companies prepare to adopt new rules in 2020 requiring a “current expected credit losses” approach under Topic 326.
As an update to the CECL approach to clarify implementation questions, FASB has already told companies they should not look to CECL to determine how to reflect losses on lease arrangements. Instead, FASB told companies to refer back to the leases guidance in ASC 842.
While ASC 842 requires companies to assess collectability on each individual lease as a condition of recognizing revenue, it does not provide for an overarching reserve on a pool of leases. That prompted some companies to apply historic loss contingency approaches to recognizing the potential for losses at the portfolio level, even while also recognizing revenue on leases under the guidance in ASC 842. Other companies are observing only the guidance in ASC 842 that calls for a lease-by-lease analysis of collectability as a condition of recognizing revenue.
The staff says in a handout to the FASB board that it recognizes the board did not mean to make any significant change to how companies deal with impairment of operating leases, but it also recognizes that a strict interpretation of ASC 842 on that point would represent a big change. As such, the FASB staff suggested the board allow companies to pick either approach, as long as they clearly disclose their accounting policy on the matter to investors and stick with it consistently.
FASB agreed with that staff recommendation, conceding it means not all companies are following the same approach. “The board decided that standard setting is currently unnecessary for this issue and instructed the staff to continue to monitor this issue for any significant diversity in practice,” FASB said.
When FASB issued its 2018 guidance telling companies that operating lease receivables were not in the scope of CECL, that led to new questions, says Scott Muir, a partner in the national office at KPMG. “Some interpreted that to mean the only reserve for operating lease receivables you could book would be where a lease is deemed not probable of collection,” he said. That would suggest the standard makes no provision for circumstances where some portion of a lessor’s receivables for leases not yet identified as having credit issues may also not be collectible.
It also means companies with receivables for both financing leases and operating leases will have to apply two different reserve methodologies for different types of leases, Muir says. “Sales-type and direct financing leases are clearly subject to CECL, but operating leases are not under this model.”
The clarity is helpful to companies that are still wading through their first year of reporting under the new standard, says Ryan Brady, a partner in the accounting principles group at Grant Thornton. It also puts to rest uncertainty around yet another area of unintended consequences produced by the new standard, he says.
“The board has been clear since initially issuing the standard it did not intend to significantly change the accounting for lessors, but as we implement in certain areas, it becomes clear that it does change practice for lessors,” Brady says.
Now that FASB has permitted either of two approaches that are developing, it will lead to differences in how companies report, says Brady. “That diversity exists today,” he says.
In practice, that means some companies will show signs of doubt about collectability sooner than others, says Barker. Companies following the reserve approach will take a big-picture approach, perhaps based on historic experience, and record a reserve to reflect how much of its lease portfolio overall it will not collect–a “haircut” on its lease receivables, says Barker.
Others, however, will make a call, lease-by-lease, on whether a given receivable is collectible. “If it’s good, its 100 percent good,” so the company will report the full expected revenue, said Barker. “We know that’s not how it always works out, which is why the general reserve methodologies are used.”
That means reporting under the strict interpretation of ASC 842 will delay recognition of any possible losses or shortfall on lease receivables essentially until they occur, which is contrary to the more forward-looking reporting required under CECL.
Hal Hunt, a shareholder at audit firm Mayer Hoffman McCann, says applying a general reserve will require historic data, which may be difficult for some companies. Different types of companies choosing different approaches creates the potential for big differences in reported outcomes, he says. “The potential is there, depending on the lessor’s portfolio and what the economy is doing,” he says.
The diversity in approach lends yet another reason to the mounting case for delaying the effective date of ASC 842 for non-public entities as public companies continue to work through issues, says Hunt. FASB has already indicated it may push a number of standards out for a number of public companies, including leases for private companies and CECL for private and smaller reporting public companies.