FASB Makes Tentative Decisions on Technical Corrections and Improvements to New Leases Standard and Discusses Revenue/Leases Transition Issue
At its June 21, 2017, Board meeting, the FASB discussed 16 proposed technical corrections and improvements to its new leases standard (ASU 2016-021), as well as a lessor-specific transition issue related to the interaction between the adoption of the new leases standard and the new revenue standard (ASU 2014-092).
Proposed Technical Corrections and Improvements
In response to feedback received from several sources, the Board proposed amendments that would clarify, rather than change, the new leases standard. The technical corrections and improvements to ASC 842,3 all of which were tentatively affirmed by the Board, are summarized in the appendix below. The Board directed its staff to draft a proposed ASU with a 45-day comment period.
Effective Date and Transition Requirements
The effective date and transition requirements under the proposed ASU would be the same as those in the new leases standard.4 However, to the extent that an entity has already adopted ASC 842, when the proposed amendments are issued as a final ASU, the amendments would be effective immediately upon issuance. If an entity has not adopted ASC 842 as of the date the proposed ASU is issued, the amendments would have the same effective date as ASU 2016-02.
Lessor Transition Issue — Allocation of Contract Consideration Between Revenue and Leases Components
ASC 606 requires entities to assess whether a contract is partially within the scope of ASC 606 and partially within the scope of other ASC topics (e.g., ASC 840). ASC 606 also provides guidance on how to separate the components of a contract that are within the scope of different ASC topics. Separation is based on the guidance in the other ASC topic if such guidance exists; otherwise, separation is based on the guidance in ASC 606 (i.e., it is based on the relative stand-alone selling price). As a result, the adoption of ASC 606 could affect contracts that include both revenue and lease components. The question addressed by the Board was whether the application of ASC 606 to prior periods should have an impact only on the revenue component of a contract or whether a lessor is required to reassess the accounting for the entire contract, including lease components. The accounting for the lease component could change if the transaction price is allocated on the basis of the relative stand-alone selling price and the amount allocated to the lease component is affected by the adoption of ASC 606.
The Board decided that an entity is not required to reallocate contract consideration between revenue and lease components when it adopts ASC 606. In other words, application of the new revenue standard should only affect the accounting for the revenue components of contracts and not the lease components. The Board indicated that this discussion will be reflected in the meeting minutes rather than requiring future standard setting.
Key provisions of the proposed amendments on technical corrections and improvements to the new leases standard are summarized in the table below, which was adapted from the June 21, 2017, meeting handout. As noted above, all of the technical corrections or improvements below were tentatively affirmed by the Board.
Area for Correction or Improvement
Summary of Proposed Amendments
Issue 1 — Residual Value Guarantee by Seller-Lessee in a Sale and Leaseback Transaction
The proposed amendment to paragraph 460-10-60-2 would correct the cross-reference between Topic 460, Guarantees, and the relevant guidance in Topic 842 about a seller-lessee’s guarantee of the underlying asset’s residual value in a sale and leaseback transaction.
Issue 2 — Rate Implicit in the Lease
The proposed amendment to the definition of the term rate implicit in the lease would clarify that a Day 1 loss is the intended accounting outcome for certain sales-type leases with significant variable payments under Topic 842 and, accordingly, that the use of a negative rate implicit in the lease is not appropriate.
Issue 3 — Lessee Reassessment of Lease Classification
The proposed amendment to paragraph 842-10-25-1 would clarify that a lessee should reassess lease classification on the basis of the facts and circumstances (and the modified terms and conditions, if applicable) as of the date the entity undertakes the reassessment or the effective date of a modification.
Issue 4 — Lessor Reassessment of Lease Term and Purchase Option
The proposed amendment to paragraph 842-10-35-3 would clarify that a lessor should account for the exercise of a lessee option as a lease modification either:
Issue 5 — Subsequent Measurement of Variable Lease Payments That Depend on an Index or a Rate
The proposed amendments would clarify that a change to a reference index or rate upon which some or all of the variable lease payments in the contract are based does not constitute the resolution of a contingency subject to the guidance in paragraph 842-10-35-4(b). [For more information on whether index- or rate-based payment adjustments in a lease require the lessee to remeasure the lease, see Deloitte’s April 25, 2017, Heads Up.]
Issue 6 — Evaluation of Investment Tax Credits
The proposed amendment to paragraph 842-10-55-8 would align the terminology used in the definition of the term rate implicit in the lease in the Master Glossary and the terminology used in paragraph 842-10-55-8 on lease classification.
Issue 7 — Lease Term and Purchase Option
The proposed amendment would clarify the guidance in paragraph 842-10-55-24 so that it better aligns with the description of a noncancellable period of a lease in paragraph 842-10-55-23.
Issue 8 — Amounts Previously Recognized in Business Combinations
The proposed amendment to paragraph 842-10-65-1(h)(3) would clarify the intent of the transition guidance provided to lessors for assets or liabilities recognized in accordance with Topic 805, Business Combinations, for favorable or unfavorable terms of an operating lease acquired as part of a business combination.
Issue 9 — Nonqualifying Initial Direct Costs for Previously Classified Operating Leases
The proposed amendment to paragraph 842-10-65-1(p) would clarify the transition guidance applicable to lease origination costs incurred by a lessee for an existing operating lease that does not meet the definition of the term initial direct costs under Topic 842 and when to recognize those costs to earnings rather than equity.
Issue 10 — Leases Previously Classified as Capital Leases Under Topic 840, Leases
The proposed amendment to paragraph 842-10-65-1(r) would correct a reference in the transition guidance applicable to lessees for leases previously classified as capital leases under Topic 840 and those classified as finance leases under Topic 842 with respect to subsequent measurement of the lease before the effective date.
Issue 11 — Lessor Accounting for Modification of Direct Financing Leases or Sales-Type Leases
The proposed amendment to paragraph 842-10-65-1(x) would clarify the transition guidance applicable to lessors for leases previously classified as sales-type leases or direct financing leases under Topic 840 and classified as sales-type leases or direct financing leases under Topic 842 with respect to modifications beginning on the effective date.
Issue 12 — Transition Guidance on Sale and Leaseback Transactions
The proposed amendments would clarify that:
Issue 13 — Impairment of the Net Investment in the Lease
The proposed amendment to paragraph 842-30-35-3 would clarify the application of the impairment guidance for the net investment in the lease, including the cash flows to consider in that impairment assessment. [For more information on determining the impairment of the net investment in a lease, see Deloitte’s April 25, 2017, Heads Up.]
Issue 14 — Accretion of Unguaranteed Residual Asset Upon the Sale of a Lease Receivable
The proposed amendment to paragraph 842-30-35-4 would clarify that a lessor is permitted to continue accreting the unguaranteed residual asset to its estimated value over the remaining lease term as long as the lessor retains a significant interest in the lease receivable.
Issue 15 — Determination of Rate Implicit in the Lease With Initial Direct Costs
The proposed amendments to the implementation guidance would clarify for lessors the effect that initial direct costs have on the determination of the rate implicit in the lease for lease classification purposes.
Issue 16 — Accounting for Failed Sale and Leaseback Transaction
The proposed amendment to paragraph 842-40-30-6 would clarify that a seller-lessee should adjust the interest rate on its financial liability as necessary to ensure that the interest on the financial liability does not exceed the total payments (rather than the principal payments) on the financial liability.
FASB Accounting Standards Update No. 2016-02, Leases.
FASB Accounting Standards Update No. 2014-09, Revenue From Contracts With Customers.
For titles of FASB Accounting Standards Codification (ASC) references, see Deloitte’s "Titles of Topics and Subtopics in the FASB Accounting Standards Codification.”
ASU 2016-02 will be effective for public business entities for period beginning after December 15, 2018 (i.e., the period beginning January 1, 2019, for calendar-year-end companies), with early adoption permitted.
The Board reiterated that it does not intend to redeliberate on the “Day 1 loss due to variable payments” issue, since most Board members believe that the lessor model is clear within the guidance. However, the proposed ASU will include an addition to the Basis for Conclusion noting that the preclusion of a negative implicit rate should not be analogized to other areas of GAAP in which a present value is used. For more information on the accounting for the Day 1 loss, see Deloitte’s April 25, 2017, Heads Up.