The Financial Accounting Standards Board (FASB) on Monday finalized an update to its leases standard (Topic 842) targeting sales-type leases with variable lease payments.

The update, advanced by the Board in April, is effective for fiscal years beginning after Dec. 15, 2021, for all entities. Lessors that have not yet adopted Topic 842 on or before fiscal years beginning after Dec. 15, 2021, should follow existing transition requirements. Lessors that have adopted Topic 842 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 is permitted.

In line with the update, 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.

The update 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 update is one of two FASB advanced in April regarding its leases standard. The other, focused on a discount rate for lessees that are not public business entities, is still in the drafting phase.