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FASB Issues Long-awaited Lease Simplification Update

With the effective date of Topic 842, Leases, right around the corner, the FASB recently issued two new ASUs that update the lease accounting guidance originally issued in 2016. Both of these updates are effective at the same time as Topic 842.

In July, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases. In this Update, the FASB addressed 16 specific issues which practitioners had identified as areas where the guidance in Topic 842 needed clarification or correction. These amendments affect narrow aspects of the guidance issued in the original new lease guidance found in ASU No. 2016-02. The amendments in this Update are of a similar nature to the items typically addressed in the FASB’s Codification Improvements project. However, the FASB decided to issue a separate Update for these improvements related to Update 2016-02 to increase stakeholders’ awareness of the amendments and to expedite the improvements. These items generally are not expected to have a significant effect on current accounting practice or create a significant administrative cost for most entities.

However, of greater significance are the additional amendments made to Topic 842 through the FASB’s issuance of ASU No. 2018-11, Leases (Topic 842): Targeted Improvements, which was also issued in July 2018. In this Update, the FASB provided a simplified transition approach when adopting the provisions of Topic 842. Under the original guidance in Topic 842, entities are required to adopt the new leases standard using a modified retrospective transition method. In this approach, they apply the new standard at the beginning of the earliest period presented in the financial statements, which is January 1, 2019, for calendar-year-end non-public business entities that adopt the new leases standard on January 1, 2020. Under this approach, starting on January 1, 2019, lessees must recognize lease assets and liabilities for all leases that exist as of that date even though those leases may expire before the effective date of the new guidance. Lessees also must provide the new and enhanced disclosures for each period presented, including the comparative periods. However, stakeholder feedback indicated unexpected costs and challenges when applying this transition method.

In response to this feedback, the FASB is providing entities with an additional, optional, transition method to adopt Topic 842. Under this new transition method, an entity initially applies the new leases standard at the adoption date, January 1, 2020 for non-public business calendar year-end entities, and recognizes a cumulative-effect adjustment to the opening balance of retained earnings as of that date. Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with current GAAP (Topic 840, Leases). An entity that elects this transition method must provide the required Topic 840 disclosures for all periods that continue to be in accordance with Topic 840, which are not impacted by this Update.

Selection of this alternative should ease the transition burden for entities, as they no longer need to consider leases that expire before the effective date of Topic 842 in their transition approach.  Accordingly, many entities are expected to elect this approach.

This Update also provides lessors with a practical expedient, by class of underlying asset, to not separate non-lease components from the associated lease component for certain leases. Instead, lessors can account for those components as a single component if the non-lease components otherwise would be accounted for as revenue under Topic 606. Additionally, both of the following conditions must be met in order to take advantage of this election:

  1. The timing and pattern of transfer of the non-lease component(s) and associated lease component are the same.
  2. The lease component, if accounted for separately, would be classified as an operating lease.

If the non-lease component or components associated with the lease component are the predominant component of the combined component, an entity is required to account for the combined component in accordance with Topic 606. Otherwise, the entity must account for the combined component as an operating lease in accordance with Topic 842.

In essence, this expedient is providing lessors with the same option which currently exists for lessees in Topic 842 for similar leases.

Together, these new alternatives should relieve much pressure which entities are facing both in adopting Topic 842 and accounting for leases on an ongoing basis. With the effective date of Topic 842 quickly approaching, entities should evaluate these options and incorporate their conclusions into their transition plans for Topic 842 as quickly as possible.

For a deeper discussion of these new options, as well as a detailed review of the new lease accounting guidance, make sure to attend Surgent’s NLS4 course, which you can register for at SurgentCPE.com.

Rich Daisley, CPA, is Senior Director, Accounting and Financial Reporting Content for Surgent CPE. With over 26 years of experience in the accounting and auditing field, Mr. Daisley has worked in both the client service setting, mainly for PwC’s Capital Markets and Accounting Advisory Services Group and for PECO Energy’s Merger and Acquisition Group, and in the internal capacity setting as a course developer and facilitator creating leading training courses for PwC and Surgent. Rich lives in suburban Philadelphia.

FASB Issues Long-awaited Lease Simplification Update was last modified: February 23rd, 2022 by Richard Daisley, CPA
Richard Daisley, CPA: