FASB Votes to Issue Proposed ASU on Two Codification Improvements to New Leasing Standard
At its December 4, 2018, meeting, the FASB added a project to its technical agenda on Codification improvements to ASC 8421 for the following two issues:
- Fair value of the underlying asset by lessors that are not manufacturers or dealers.
- Statement of cash flows presentation for sales-type and direct financing leases.
This journal entry includes a summary of the tentative decisions reached and related discussion at the meeting.
Fair Value of the Underlying Asset by Lessors That Are Not Manufacturers or Dealers
ASC 840-10-55-44 provides guidance for determining fair value and its application to lease classification and measurement for lessors who are not manufacturers or dealers (qualifying lessors), stating that:
"If the lessor is not a manufacturer or dealer, the fair value of the property at lease inception ordinarily will be its cost, reflecting any volume or trade discounts that may apply. However, if there has been a significant lapse of time between the acquisition of the property by the lessor and lease inception, the determination of fair value should be made in light of market conditions prevailing at lease inception, which may indicate that the fair value of the property is greater or less than its cost or carrying amount, if different."
ASC 842, as issued, eliminated this fair value exception. Instead, ASC 842 requires that the definition of fair value established in ASC 820 be applied for all aspects of lease accounting in ASC 842.
Recently, stakeholders communicated to the FASB that “not carrying forward the fair value exception to [ASC] 842 will have significant adverse financial reporting consequences for qualifying lessors.”2 Specifically, as written, a lessor that is not a manufacturer or dealer would be required to recognize (i.e., expense) acquisition costs (e.g., sales taxes and delivery charges) at lease commencement, resulting in a day-one loss under ASC 842. Further, to recover these costs, a qualifying lessor would recognize interest income for sales-type and direct financing leases that is significantly greater than that being recognized under ASC 840. Stakeholders also expressed that they believe this accounting outcome “is neither useful to investors nor representative of their business model of financing the total cost of the underlying asset to the lessee.”
In response to this issue, the Board tentatively decided to amend ASC 842 to provide a similar fair value exception as is provided in ASC 840-10-55-44.
Statement of Cash Flows Presentation for Sales-Type and Direct Financing Leases
ASC 842 contains guidance that conflicts with industry-specific GAAP for depository and lending lessors on the presentation of principal payments received from sales-type and direct financing leases. That is, ASC 842 requires all lessors to classify cash receipts from leases within “operating activities” in accordance with ASC 842-30-45-5, while ASC 942 provides an example3 that classifies principal payments received under leases as investing activities for entities within the scope of ASC 942. (This example existed before, and was not consequentially amended by, the issuance of ASC 842.)
The Board tentatively decided to retain the guidance that exists in ASC 942. Accordingly, depository and lending lessors should classify principal payments received from sales-type and direct financing leases within “investing activities.”
Transition and Effective Date
The Board tentatively decided that the amendments would be effective for all entities for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption would be permitted for all entities. Further, the Board tentatively decided the proposed Codification improvements should be applied on the date the entity first applied ASU 2016-024 in accordance with ASC 842-10-65-1(c).
Connecting the Dots
The FASB intentionally “deferred” the effective date of this proposed ASU by one year relative to the effective date of ASU 2016-02 to provide entities with more time to adopt the proposed amendments. The Board was concerned that there could be lessors that may not be aware of the proposed amendments in a timely manner to require adoption at the effective date of ASU 2016-02. However, the Board is permitting early adoption and we expect that most qualifying lessors will early adopt the proposed ASU.
The FASB directed its staff to draft a proposed ASU on the two Codification improvements, which it expects to issue in December or January. Comments will be due 15 days from issuance or January 15, 2019, whichever is longer.