by Elena Cilenti and Kristin Bauer, Deloitte & Touche LLP
On July 30, 2018, the FASB issued ASU 2018-111 to provide entities with relief from the costs
of implementing certain aspects of the new leasing standard, ASU 2016-022 (codified as ASC
842).3 Specifically, under the amendments in ASU 2018-11:
Entities may elect not to recast the comparative periods presented when transitioning
to ASC 842 (Issue 1).
Lessors may elect not to separate lease and nonlease components when certain
conditions are met (Issue 2).
These amendments are consistent with the tentative decisions that the Board made at its
November 29, 2017, meeting4 and further refined at its March 7, 2018,5 and March 28, 2018,
In addition, on July 19, 2018, the FASB issued ASU 2018-10,7 which made 16 separate
amendments to ASC 842. For more information on these amendments, see the appendix.
Key Provisions of ASU 2018-11
The scope of the amendments in the ASU is as follows:
Transition Relief (Issue 1) — These amendments, which allow entities to report the
comparative periods presented in the period of adoption under ASC 840, affect all
entities with lease contracts that elect not to restate their comparative periods in
Lessor Relief (Issue 2) — These amendments, which give lessors the option of electing,
as a practical expedient by class of underlying asset, not to separate the lease and
nonlease components of a contract, only affect lessors whose lease contracts meet
certain criteria (discussed below).
Note that while the Issue 1 amendments may benefit both lessees and lessors, the Issue 2
amendments will benefit only lessors.
Transition Relief (Issue 1)
ASC 842 originally required all entities to use a “modified retrospective” transition approach
that is intended to maximize comparability and be less complex than a full retrospective
approach. (See Deloitte’s A Roadmap to Applying the New Leasing Standard for further
discussion of the effective date and transition guidance in ASC 842.)
Under the modified retrospective approach, ASC 842 is effectively implemented as of the
beginning of the earliest comparative period presented in an entity’s financial statements. That
is, a public business entity for which the standard becomes effective on January 1, 2019, would
first apply ASC 842 and recognize an adjustment for the effects of the transition as of January
1, 2017 (i.e., the date of initial application).
ASU 2018-11 amends ASC 842 so that entities may elect not to recast their comparative
periods in transition (the “Comparatives Under 840 Option”). The ASU allows entities to change
their date of initial application to the beginning of the period of adoption. Therefore, a public
business entity with a calendar year-end could elect to have a date of initial application of
January 1, 2019. In doing so, the entity would:
Apply ASC 840 in the comparative periods.
Provide the disclosures required by ASC 840 for all periods that continue to be
presented in accordance with ASC 840.
Recognize the effects of applying ASC 842 as a cumulative-effect adjustment to
retained earnings as of January 1, 2019.
The entity would not:
Restate 2017 and 2018 for the effects of applying ASC 842.
Provide the disclosures required by ASC 842 for 2017 and 2018.
Change how it applies the transition requirements, only when it applies the transition
Connecting the Dots — ASC 840 Disclosures Required in the Comparative
In response to the discussion at its March 7, 2018, meeting, the Board revised the language
in ASU 2018-11 to clarify that an entity must provide the ASC 840 disclosures for all periods
that are presented in accordance with ASC 840. As part of this requirement, the entity must
apply the guidance in ASC 840-20-50-2(a) (commonly referred to as the “five-year table”)
as of the latest balance sheet presented. Further, the ASU indicates that the latest balance
sheet date presented should be the latest balance sheet date presented under ASC 840 (e.g.,
December 31, 2018, for a public business entity with a calendar year-end). Therefore, for a
public business entity with a calendar year-end, the ASC 840-20-50-2(a) five-year table as of
December 31, 2018, will be presented in the annual financial statements for the year ended
December 31, 2019. Also, paragraph BC14 of ASU 2018-11 indicates that the ASU does not
change, or create additional, “interim disclosure requirements that entities previously were
not required to provide.”
We believe that it is still unclear what the U.S. GAAP and SEC reporting requirements would
be with respect to the five-year table in the first interim period in the year of adoption of ASC
842. While ASC 842 may not require entities to provide certain of the prescribed disclosures
in interim financial statements, SEC rules and staff interpretations require SEC registrants to
provide both annual and interim disclosures in the first interim period after the adoption of a
new accounting standard and in each subsequent quarter in the year of adoption. Specifically,
Section 1500 of the SEC Financial Reporting Manual states:
[Regulation] S-X Article 10 requires disclosures about material matters that were not
disclosed in the most recent annual financial statements. Accordingly, when a registrant
adopts a new accounting standard in an interim period, the registrant is expected
to provide both the annual and the interim period financial statement disclosures
prescribed by the new accounting standard, to the extent not duplicative. These
disclosures should be included in each quarterly report in the year of adoption.
We plan to seek further guidance from the FASB regarding what disclosures are required in
interim periods during the year of adoption.
Effective Date and Transition
The transition relief amendments (Issue 1) in the ASU apply to entities that have not yet
adopted ASC 842. Entities that have early adopted ASC 842 cannot elect the Comparatives
Under ASC 840 Option.
Lessor Relief (Issue 2)
ASU 2016-02, as initially issued, required lessors to separate lease and nonlease components
in all circumstances. Under this requirement, once separate components are identified,
lessors are required to use the relative stand-alone selling price allocation method in ASC 606
to allocate the consideration in the contract to the separated components. ASC 842 (including
the presentation and disclosure guidance) applies to the lease component, while other
guidance, typically ASC 606 (including the presentation and disclosure guidance), applies to
the nonlease component.
As a result of stakeholder feedback indicating that the costs of complying with the separation
and allocation requirements for lessors outweigh the benefits, ASU 2018-11 amends ASC 842
to include a practical expedient under which lessors are not required to separate lease and
Connecting the Dots — Practical Expedient Creates Greater Alignment
Between Lessee and Lessor Accounting
ASU 2018-11 aligns the lessor’s accounting for the separation of lease and nonlease
components with that for lessees. Unlike lessors, lessees have always been able, under ASC
842, to elect a practical expedient under which they can choose not to separate (and allocate
consideration to) lease and nonlease components (see ASC 842-10-15-37). However, lessees
do not have an option of accounting for the combined component under ASC 842 or other
U.S. GAAP. A lessee’s combined component must always be accounted for under ASC 842.
Both lessors and lessees may now elect to account for the nonlease components in a contract
as part of the single lease component to which they are related. Note that this election is an
accounting policy election that must be made by class of underlying asset.
Criteria for Combining Lease and Nonlease Components
A lessor may elect to combine lease and nonlease components provided that the nonlease
component(s) otherwise would be accounted for under the new revenue guidance in ASC 606
and both of the following conditions are met:
Criterion A — The timing and pattern of transfer for the lease component are the same
as those for the nonlease components associated with that lease component.
Criterion B — The lease component, if accounted for separately, would be classified as
an operating lease.
The ASU also clarifies that the presence of a nonlease component that is ineligible for the
practical expedient does not preclude a lessor from electing the expedient for the lease
component and nonlease component(s) that meet the criteria. Rather, the lessor would
account for the nonlease components that do not qualify for the practical expedient
separately from the combined lease and nonlease components that do qualify.
Connecting the Dots — Assessing Timing and Pattern of Transfer
In the final ASU, the Board amended Criterion A to focus on the timing and pattern of transfer
(i.e., a “straight-line pattern of transfer . . . to the customer over the same time period”) rather
than on the timing and pattern of revenue recognition (as was originally proposed). The
purpose of this amendment was to address concerns that the originally proposed practical
expedient was unnecessarily restrictive and excluded contracts with variable consideration
from its scope, since variable payments are accounted for differently under ASC 606 than they
are under ASC 842.
Determining Which Component Is Predominant
As with the lessee practical expedient, the FASB originally proposed that a lessor should
always be required to account for the combined component as a lease under ASC 842.
However, on the basis of feedback it received, the Board revised the final ASU to require an
entity to perform another evaluation to determine whether the combined unit of account is
accounted for as a lease under ASC 842 or as a revenue contract under ASC 606. Specifically,
an entity should determine whether the nonlease component (or components) associated
with the lease component is the predominant component of the combined component. If so,
the entity is required to account for the combined component in accordance with ASC 606.
Otherwise, the entity must account for the combined component as an operating lease in
accordance with ASC 842.
Connecting the Dots — An Entity Will Need to Use Judgment to Determine
the Predominant Component
As indicated in the ASU’s Background Information and Basis for Conclusions, the FASB
decided not to include a separate definition or threshold for determining whether “the
nonlease component is the predominant component in the combined component.” Rather,
the Board indicates that an entity should consider whether it would “ascribe more value to the
nonlease component(s) than to the lease component.” Further, the Board acknowledged that
the term “predominant” is used elsewhere in U.S. GAAP, including ASC 8428 and ASC 606.9
The FASB also indicates that it is comfortable with allowing entities to use judgment in making
this determination. The Board explains that it does not expect that an entity will need to
perform a detailed quantitative analysis or allocation to determine whether the nonlease
component is predominant. Rather, it is sufficient if an entity can reasonably determine
whether to apply ASC 842 or ASC 606.
At its March 28, 2018, meeting, the Board discussed a scenario in which the components
were evenly split (e.g., a 50/50 split of value) and suggested that, in such circumstances,
the combined component should be accounted for under ASC 842 because the nonlease
component is not predominant. That is, the entity would need to demonstrate that the
predominant element is the nonlease component; otherwise, the combined unit of account
would be accounted for as a lease under ASC 842.
We believe that the final language in the ASU is intended to indicate that an entity would need
to determine whether the lease or nonlease component (or components) is larger (i.e., has
more value); only when the nonlease component is larger should the combined component
be accounted for under ASC 606.
Connecting the Dots — Accounting for Variable Payments Follows the
Scoping of the Combined Component
At its March 28, 2018, meeting, the Board decided that the Background Information and
Basis for Conclusions of the new leasing standard should include language regarding the
interaction between the practical expedient and the guidance in (1) ASC 842-10-15-39
on consideration in the contract and (2) ASC 842-10-15-40 on the recognition of variable
payments. Specifically, the ASU clarified the Board’s intent that the accounting for variable
payments should be consistent with that for the combined component. That is, when the
combined component is accounted for as a lease under ASC 842, there are no longer any
nonlease variable payments; rather, there are only variable payments related to the combined
lease component. Conversely, if the combined component is accounted for as a service under
ASC 606, all variable payments related to the combined component should be accounted for
in accordance with the variable consideration guidance in ASC 606.
A lessor must disclose the following by class of underlying asset: (1) that it has elected the
practical expedient, (2) the class(es) of underlying asset for which the election was made,
(3) the nature of the items that are being combined and any nonlease components that
were not eligible for the practical expedient, and (4) which standard applies to the combined
component (i.e., ASC 842 or ASC 606).
The flowchart below summarizes when a lessor may apply the practical expedient related to
not separating lease and nonlease components in a contract.
For entities that have not yet adopted ASU 2016-02, the effective date of the lessor relief
practical expedient (Issue 2) is aligned with the new leasing standard’s effective date and
transition requirements. That is, the expedient’s effective date is as follows:
Public business entities — Fiscal years beginning after December 15, 2018, and interim
periods within those fiscal years.
All other entities — Fiscal years beginning after December 15, 2019, and interim periods
within fiscal years beginning after December 15, 2020.
Entities that early adopted ASU 2016-02 before the issuance of ASU 2018-11 may apply the
lessor practical expedient to all new and existing leases either retrospectively or prospectively
and may elect to apply it as of either (1) the lessor’s first reporting period after the issuance
of the ASU or (2) the mandatory effective date of ASC 842 (i.e., January 1, 2019, for calendar-year-end public entities). For example, an entity that has early adopted ASU 2016-02 and
elects the practical expedient may decide not to recast past periods already presented under
ASC 842, thereby choosing prospective application.
Upon transition to ASU 2018-11, a lessor electing the practical expedient would be required
to apply it to all new and existing transactions within a class of underlying assets that qualify
for the expedient as of the date elected. That is, a lessor would not be permitted to apply the
practical expedient only to new or modified transactions within a class of underlying assets.
Connecting the Dots
At its July 25, 2018, meeting,11 the FASB also deliberated potential Codification
improvements to the amendments in ASU 2016-13,12 including clarifying the accounting for
the impairment of operating lease receivables. The Board tentatively decided to clarify that
operating lease receivables are not within the scope of ASC 326 and will expose this
decision for public comment. For more information on the Board’s proposed amendments
to the current expected credit losses standard, see Deloitte’s July 27, 2018, journal entry.
Appendix — Minor Amendments Made by ASU 2018-10 to New Leasing Standard
ASU 2018-1013 (issued on July 19, 2018) makes narrow-scope amendments (i.e., minor changes and clarifications)
to certain aspects of the new leasing standard (i.e., ASC 842). The following table, reproduced from the final ASU,
summarizes the 16 amendments that were made:
Area for Improvement
Summary of Amendments
Issue 1: Residual Value Guarantees
Stakeholders noted that paragraph 460-10-60-32 incorrectly
refers readers to the guidance in Topic 842 about sale-leaseback-sublease transactions, when, in fact, it should refer
readers to the guidance about guarantees by a seller-lessee
of the underlying asset’s residual value in a sale and leaseback
The amendment corrects the cross-reference in paragraph
Issue 2: Rate Implicit in the Lease
Stakeholders raised questions about the treatment of certain
sales-type leases with significant variable payments under Topic
842 and whether the application of Topic 842 could result in
a negative rate implicit in the lease, rather than a loss at the
commencement date of the lease.
The amendment clarifies that a rate implicit in the lease of zero
should be used when applying the definition of the term rate
implicit in the lease results in a rate that is less than zero.
Issue 3: Lessee Reassessment of Lease Classification
Topic 842 is clear that when a lease is modified and that
modification is not accounted for as a separate contract, an
entity (that is, a lessee or a lessor) should reassess, at the
effective date of the modification, lease classification on the
basis of the modified terms and conditions and the facts and
circumstances existing as of that date. Although Topic 842 also
requires a lessee to reassess lease classification if there is a
change in the lease term or the assessment of a lessee option
to purchase the underlying asset, stakeholders expressed
that it is not clear whether the lessee should reassess lease
classification on the basis of the facts and circumstances
existing as of the date the reassessment is required.
The amendment consolidates the requirements about
lease classification reassessments into one paragraph and
better articulates how an entity should perform the lease
classification reassessment, that is, on the basis of the facts
and circumstances, and the modified terms and conditions, if
applicable, as of the date the reassessment is required.
Issue 4: Lessor Reassessment of Lease Term and Purchase Option
Topic 842 requires a lessor to not reassess the lease term or
a lessee purchase option unless the lease is modified and that
modification is not accounted for as a separate contract. Topic
842 also requires a lessor to account for the exercise of a lessee
option to extend or terminate the lease or to purchase the
underlying asset in the same manner as a lease modification.
Stakeholders questioned why a lessor should account for a
lessee exercise of such options in a manner similar to a lease
modification when the exercise of those options is consistent
with the assumptions that the lessor made in accounting for
the lease at the commencement date of the lease (or the most
recent effective date of a modification that is not accounted for
as a separate contract).
The amendment clarifies that a lessor should account for
the exercise by a lessee of an option to extend or terminate
the lease or to purchase the underlying asset as a lease
modification unless the exercise of that option by the lessee
is consistent with the assumptions that the lessor made in
accounting for the lease at the commencement date of the
lease (or the most recent effective date of a modification that is
not accounted for as a separate contract).
Issue 5: Variable Lease Payments That Depend on an Index or a Rate
Stakeholders noted that the guidance in paragraph 842-10-35-4(b) about remeasurement of the lease payments when
a contingency upon which some or all of the variable lease
payments are based is resolved might be perceived as applying
to any variable lease payments, including those that depend on
an index or rate, which would be inconsistent with the Board’s
decisions on this issue.
The amendment clarifies that a change in 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). Variable lease payments that depend on an index
or a rate should be remeasured, using the index or rate at
the remeasurement date, only when the lease payments are
remeasured for another reason (that is, when one or more of
the events described in paragraph 842-10-35-4(a) or (c) occur
or when a contingency unrelated to a change in a reference
index or rate under paragraph 842-10-35-4(b) is resolved).
Issue 6: Investment Tax Credits
Stakeholders indicated that there is an inconsistency in
terminology used about the effect that investment tax credits
have on the fair value of the underlying asset between the
definition of the term rate implicit in the lease and the lease
classification guidance in paragraph 842-10-55-8.
The amendment removes that inconsistency in terminology.
Issue 7: Lease Term and Purchase Option
Stakeholders indicated that the description in paragraph
842-10-55-24 about lessor-only termination options is
inconsistent with the description in paragraph 842-10-55-23
about the noncancellable period of a lease.
The amendment removes that inconsistency by clarifying that
the period covered by a lessor-only option to terminate the
lease is included in the lease term.
Issue 8: Transition Guidance for Amounts Previously Recognized in Business Combinations
Stakeholders indicated that the transition guidance for lessors
in paragraph 842-10-65-1(h)(3) is unclear because it relates to
leases classified as direct financing leases or sales-type leases
under Topic 840, while the lead-in sentence to paragraph
842-10-65-1(h) provides transition guidance for leases classified
as operating leases under Topic 840.
The amendment clarifies that paragraph 842-10-65-1(h)(3)
applies to lessors for leases classified as direct financing leases
or sales-type leases under Topic 842, not Topic 840. In other
words, paragraph 842-10-65-1(h)(3) applies when an entity
does not elect the package of practical expedients in paragraph
842-10-65-1(f), and, for a lessor, an operating lease acquired as
part of a previous business combination is classified as a direct
financing lease or a sales-type lease when applying the lease
classification guidance in Topic 842. The amendment also cross-references
to other transition guidance applicable to those
changes in lease classification for lessors.
Issue 9: Certain Transition Adjustments
When an entity initially applies Topic 842 retrospectively to
each prior reporting period and does not elect the package of
practical expedients in Topic 842, paragraph 842-10-65-1(p)
requires a lessee to write off, as an adjustment to equity, any
unamortized initial direct costs that do not meet the definition
of initial direct costs under Topic 842 for leases previously
classified as operating leases under Topic 840. Stakeholders
questioned why those nonqualifying costs should be charged to
equity when those costs are incurred after the beginning of the
earliest period presented in the financial statements in which
an entity adopts Topic 842. Similar issues also were noted
elsewhere in the transition guidance when an entity initially
applies Topic 842 retrospectively to each prior reporting period.
The amendments clarify whether to recognize a transition
adjustment to earnings rather than through equity when an
entity initially applies Topic 842 retrospectively to each prior
Issue 10: Transition Guidance for Leases Previously Classified as Capital Leases Under Topic 840
Paragraph 842-10-65-1(r) provides guidance to lessees for
leases previously classified as capital leases under Topic 840
and classified as finance leases under Topic 842. Paragraph
842-10-65-1(r)(4) provides subsequent measurement guidance
before the effective date when an entity initially applies Topic
842 retrospectively to each prior reporting period, but it refers
readers to the subsequent measurement guidance in Topic 840
about operating leases. It should refer them to the subsequent
measurement guidance applicable to capital leases.
The amendment corrects that reference.
Issue 11: Transition Guidance for Modifications to Leases Previously Classified as Direct Financing or Sales-Type Leases
Under Topic 840
Paragraph 842-10-65-1(x) provides transition guidance
applicable to lessors for leases previously classified as direct
financing leases or sales-type leases under Topic 840 and
classified as direct financing leases or sales-type leases under
Topic 842. For modifications to those leases beginning after
the effective date, paragraph 842-10-65-1(x)(4) refers readers
to other applicable guidance in Topic 842 to account for the
modification, specifically paragraphs 842-10-25-16 through
25-17, depending on how the lease is classified after the
modification. Stakeholders noted that it should refer to how the
lease is classified before the modification to be consistent with
the guidance provided in paragraphs 842-10-25-16 through
The amendment corrects that inconsistency.
Issue 12: Transition Guidance for Sale and Leaseback Transactions
Stakeholders noted that the heading above the transition
guidance on sale and leaseback transactions appears to suggest
that there is no transition guidance for sale and leaseback
transactions that occur after the earliest comparative period
presented in the financial statements in which an entity adopts
Topic 842 but before the effective date. Some stakeholders
also questioned some of the references included in paragraph
The amendments clarify that the transition guidance on sale
and leaseback transactions in paragraph 842-10-65-1(aa)
through (ee) applies to all sale and leaseback transactions that
occur before the effective date and corrects the referencing
Issue 13: Impairment of Net Investment in the Lease
Paragraph 842-30-35-3 provides guidance to lessors for
determining the loss allowance of the net investment in the
lease and describes the cash flows that should be considered
when the lessor determines that loss allowance. Stakeholders
questioned whether the guidance, as written, would accelerate
and improperly measure the loss allowance because the cash
flows associated with the unguaranteed residual asset appear
to be excluded from the evaluation.
The amendment clarifies the application of the guidance for
determining the loss allowance of the net investment in the
lease, including the cash flows to consider in that assessment.
Issue 14: Unguaranteed Residual Asset
Paragraph 842-30-35-4 provides guidance explaining that
if a lessor sells the lease receivable associated with a direct
financing lease or a sales-type lease and retains an interest in
the residual value of the asset, the lessor should not continue
to accrete the unguaranteed residual asset to its estimated
value over the remaining lease term. Stakeholders questioned
whether the Board intended to change the application
as compared with current generally accepted accounting
principles (GAAP) because the guidance in paragraph 840-30-35-53 (which will be superseded by the amendments in Update
2016-02) requires a lessor to continue to recognize interest
resulting from accretion of the unguaranteed residual asset to
its estimated value unless the lessor sells substantially all of the
minimum rental payments.
The amendment clarifies that a lessor should not continue to
accrete the unguaranteed residual asset to its estimated value
over the remaining lease term to the extent that the lessor sells
substantially all of the lease receivable associated with a direct
financing lease or a sales-type lease, consistent with Topic 840.
Issue 15: Effect of Initial Direct Costs on Rate Implicit in the Lease
Stakeholders noted that the ordering of the illustration in Case
C of Example 1 in paragraphs 842-30-55-31 through 55-39
has raised questions about how initial direct costs factor into
determining the rate implicit in the lease for lease classification
purposes for lessors only.
The amendment more clearly aligns the illustration to the
guidance in paragraph 842-10-25-4.
Issue 16: Failed Sale and Leaseback Transaction
In accordance with Subtopic 842-40, Leases—Sale and
Leaseback Transactions, when a sale and leaseback transaction
does not qualify as a sale, an entity should account for the
transaction as a financing arrangement. Paragraph 842-40-30-6(a) further requires a seller-lessee to adjust the interest
rate as necessary to prevent negative amortization of the
financial liability recognized. Some stakeholders questioned
whether the language used in paragraph 842-40-30-6(a) actually
meets the objective of preventing negative amortization of the
financial liability recognized by a seller-lessee in a failed sale and
The amendment clarifies that a seller-lessee in a failed sale
and leaseback transaction 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. This
clarification is also reflected in the relevant illustration on failed
sale and leaseback transactions that is contained in Subtopic
ASC 842-10-25-5 states that “an entity shall consider the remaining economic life of the predominant asset in the lease component”
to determine the classification when multiple underlying assets comprise a single lease component.
ASC 606-10-55-65A allows entities to use the sales-based and usage-based royalty exception to estimating variable consideration
when “a license of intellectual property is the predominant item to which the royalty relates (for example, the license of intellectual
property may be the predominant item to which the royalty relates when the entity has a reasonable expectation that the customer
would ascribe significantly more value to the license than to the other goods or services to which the royalty relates).”
An entity must apply the practical expedient, when elected, to all eligible nonlease components by class of underlying asset;
however, the presence of a nonlease component (or components) that is ineligible for the practical expedient does not preclude a
lessor from applying the practical expedient.
The effective date of the amendments in ASU 2018-10 is aligned with that of ASU 2016-02. For entities that have early adopted ASC 842, the ASU is effective upon
issuance and has the same transition requirements as those in ASC 842.