Lessor Narrow-Scope Improvements
ASU 2018-20—Leases (Topic 842): Narrow-Scope Improvements for Lessors
On February 25, 2016, the FASB issued Accounting Standards Update No. 2016- 02, Leases (Topic 842), to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet and disclosing key information about leasing transactions. The FASB has been assisting stakeholders with implementation questions and issues as organizations prepare to adopt the new lease requirements.
Since the issuance of Update 2016-02, lessor stakeholders have informed the Board about certain issues that they are experiencing on the following when applying Topic 842:
- Sales taxes and other similar taxes collected from lessees
- Certain lessor costs
- Recognition of variable payments for contracts with lease and nonlease components.
Sales Taxes and Other Similar Taxes Collected from LesseesThe guidance in Topic 842 requires lessors to analyze sales taxes and other similar taxes on a jurisdiction-by-jurisdiction basis to determine whether those taxes are the primary obligation of the lessor as owner of the underlying asset being leased or whether those taxes are collected by the lessor on behalf of third parties. When a sales (or other similar) tax is collected from a lessee on behalf of third parties (that is, the lessor is acting as an agent), a lessor excludes that amount from (lease) revenue. When the lessor is primarily obligated for payment of the tax, the lessor accounts for the payment as a lessor cost and includes that amount in (lease) revenue and costs.
Lessor stakeholders observed that evaluating whether sales taxes and other similar taxes are collected on behalf of third parties would be costly and complex because of the number of jurisdictions and the variation of, and changes in, tax laws among those jurisdictions. Those lessor stakeholders also observed that users of financial statements would be provided with limited financial reporting benefits because the net effect of recording those taxes would be zero in the income statement. They also noted that the Board provided stakeholders with relief for a similar requirement in the new revenue guidance in the amendments in Accounting Standards Update No. 2016-12, Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients, whereby an entity can make an accounting policy election to exclude amounts collected from customers for all sales (and other similar) taxes from the transaction price.
The amendments in this Update provide an accounting policy election for lessors similar to the accounting policy election provided in the amendments in Update 2016-12.
Certain Lessor CostsA lessor may incur various costs in its role as a lessor or as owner of the underlying asset (lessor costs). A requirement for the lessee to pay those costs, whether directly to a third party on behalf of the lessor or as a reimbursement to the lessor, does not transfer a good or service to the lessee separately from the right to use the underlying asset. The new leases guidance requires a lessor to report those amounts as revenue and expenses.
Lessor stakeholders observed that reporting certain lessor costs paid by lessees directly to third parties on behalf of the lessor would be costly and complex, and, perhaps, not possible, in many situations. Lessor stakeholders also contended that recording those amounts would provide users of financial statements with limited financial reporting benefits for several reasons. First, because the amounts reported would often be based on estimates that are affected by lessee-specific factors and information that is not readily available to the lessor, the estimated amounts may be unreliable. Consequently, reporting those amounts may not provide users of financial statements with meaningful financial information. Second, because the amounts would be reported as both revenue and expenses by the lessor for the same amount (assuming no profit margin on those costs), the net effect would be zero in the income statement. Those lessor stakeholders also noted that similar application relief was discussed by the Board during deliberations of Accounting Standards Update No. 2016-08, Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net), for variable payments when an entity is considered a principal but the uncertainty upon which the variable payments are based is not expected to ultimately be resolved.
The amendments in this Update address stakeholders’ concerns about the operability challenges encountered in determining certain lessor costs paid by lessees directly to third parties by requiring lessors to exclude from variable payments, and thus from lease revenue, lessor costs paid by a lessee directly to a third party. The amendments also clarify that costs excluded from the consideration in a contract that are paid directly to a third party by a lessor and reimbursed by the lessee are lessor costs to be accounted for as variable payments.
Recognition of Variable Payments for Contracts with Lease and Nonlease ComponentsThe guidance in paragraph 842-10-15-40 requires lessors to recognize certain variable payment amounts in profit or loss in the period when the changes in facts and circumstances on which the variable payment is based occur, regardless of whether the payment partially relates to nonlease components.
Some stakeholders observed that this guidance might result in a lessor recognizing revenue for a nonlease component in a period in advance of the period in which the nonlease component is satisfied under another Topic, such as Topic 606, Revenue from Contracts with Customers. Therefore, those stakeholders requested amendments (or clarification) about that paragraph’s intent.
The amendments in this Update clarify the accounting by lessors for variable payments that relate to both a lease component and a nonlease component.
The amendments in this Update related to sales taxes and other similar taxes collected from lessees affect all lessors that elect the accounting policy election.
The amendments in this Update related to lessor costs affect all lessor entities that have lease contracts that either require lessees to pay lessor costs directly to a third party or require lessees to reimburse lessors for costs paid by lessors directly to third parties.
The amendments in this Update related to recognition of variable payments for contracts with lease and nonlease components affect all lessor entities with variable payments that relate to both lease and nonlease components.
Sales Taxes and Other Similar Taxes Collected from LesseesThe amendments in this Update permit lessors, as an accounting policy election, to not evaluate whether certain sales taxes and other similar taxes are lessor costs (as described in paragraph 842-10-15-30(b)) or lessee costs. Instead, those lessors will account for those costs as if they are lessee costs. Consequently, a lessor making this election will exclude from the consideration in the contract and from variable payments not included in the consideration in the contract all collections from lessees of taxes within the scope of the election and will provide certain disclosures.
Certain Lessor CostsThe amendments in this Update related to certain lessor costs require lessors to exclude from variable payments, and therefore revenue, lessor costs paid by lessees directly to third parties. The amendments also require lessors to account for costs excluded from the consideration of a contract that are paid by the lessor and reimbursed by the lessee as variable payments. A lessor will record those reimbursed costs as revenue.
Recognition of Variable Payments for Contracts with Lease and Nonlease ComponentsThe amendments in this Update related to recognizing variable payments for contracts with lease and nonlease components require lessors to allocate (rather than recognize as currently required) certain variable payments to the lease and nonlease components when the changes in facts and circumstances on which the variable payment is based occur. After the allocation, the amount of variable payments allocated to the lease components will be recognized as income in profit or loss in accordance with Topic 842, while the amount of variable payments allocated to nonlease components will be recognized in accordance with other Topics, such as Topic 606.
Transition and Effective Dates
The amendments in this Update affect the amendments in Update 2016-02, which are not yet effective but can be early adopted. The effective date and transition requirements for the amendments in this Update for entities that have not adopted Topic 842 before the issuance of this Update are the same as the effective date and transition requirements in Update 2016-02 (for example, January 1, 2019, for calendar-year-end public business entities).
For entities that have adopted Topic 842 before the issuance of this Update, the transition and effective date of the amendments in this Update are as follows:
- An entity should apply the amendments at the original effective date of Topic 842 for the entity. Alternatively, the entity has the option to apply the amendments in either the first reporting period ending after the issuance of this Update (for example, December 31, 2018) or in the first reporting period beginning after the issuance of this Update (for example, January 1, 2019).
- An entity may apply the amendments either retrospectively or prospectively.