FASB Issues Narrow-Scope Improvements for Lessors

Summary

The FASB issued ASU 2018-20^[1] to simplify three parts of ASC 842^[2] for lessors.  The ASU is available here, and it has the same effective dates and transition requirements as ASU 2016-02^[3] except for entities that have already adopted the new lease standard.

 

Main Provisions

The amendments in ASU 2018-20 make targeted improvements for lessors in the following three specific areas:

• 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 Lessees
What was the issue? Prior to ASU 2018-20, ASC 842 required lessors to analyze sales taxes and other similar taxes on a jurisdiction-by-jurisdiction basis to determine whether those taxes are a lessor cost because the lessor is the primary obligor (in which case those taxes should be reported gross in the income statement), or a lessee cost (in which case the lessor is acting as an agent of the lessee and the taxes are therefore not reported in the income statement).
 
Lessor stakeholders noted that the requirement to analyze those taxes on a jurisdiction-by-jurisdiction basis is costly and complex, considering the number of jurisdictions to evaluate and variations in tax laws. That requirement also produced limited benefits, i.e., a net effect of zero in the income statement.
 
Amendments in ASU 2018-20: Now, lessors will have an accounting policy election similar to the option in ASC 606.^[4] Lessors making this election will:

1. Exclude sales and similar taxes from the consideration in the contract and from variable payments not included in the consideration in the contract

2. Account for those costs as if they are lessee costs

3. Provide certain disclosures under ASC 842-30-50-14.

 
Said another way, lessors electing this accounting policy will not report sales and similar taxes within in the income statement, but simply on the balance sheet as payments are received/made.
Taxes assessed on a lessor’s gross receipts or on the lessor as owner of the underlying asset (for example, property taxes) are excluded from the scope of this lease accounting policy.
 
Certain Lessor Costs
What was the issue? Prior to ASU 2018-20, ASC 842 required lessors to report on a gross basis in the income statement lessor costs paid by lessees, regardless of whether the lessee paid those lessor costs directly to third-parties or reimbursed the lessor. Examples of such lessor costs include property taxes and insurance.
 
Lessor stakeholders noted that this requirement is costly and complex, particularly in net lease structures. For example, insurance payments made by a lessee directly to an insurance company are impacted by lessee-specific factors and other information that is often not readily available to the lessor. Similar to the sales tax issue, this information has a net effect of zero in the income statement.
 
Amendments in ASU 2018-20. The amendments require lessors to exclude from variable payments lessor costs paid by lessees directly to third parties. In other words, those amounts are not reported in the lessor’s income statement.
 
In contrast, ASU 2018-20 requires lessors to report costs paid by the lessor and reimbursed by the lessee as variable payments. That is, these costs are known by the lessor and will be reported on a gross basis in the income statement.
 
Recognition of Variable Payments for Contracts with Lease and Nonlease Components
What was the issue? Prior to ASU 2018-20, ASC 842 required lessors to recognize in the income statement certain variable payments when the changes in facts and circumstances on which the payment is based occurs.
 
Some lessor stakeholders questioned whether that guidance would result in the recognition of revenue in advance of when ASC 606 would otherwise require.
 
Amendments in ASU 2018-20. The amendments require lessors to allocate (rather than recognize) those variable payments to the lease and nonlease components when the changes in facts and circumstances on which the payment is based occurs. After that allocation, the lessor applies the recognition guidance in ASC 842 for the amounts allocated to the lease component and applies the recognition guidance in other GAAP (typically, ASC 606) for the amounts allocated to the nonlease components.

 

Effective Date and Transition Requirements

The effective date and transition requirements for ASU 2018-20 depend on whether entities already adopted the new lease standard.
 
Entities that have not adopted ASC 842 before the issuance of ASU 2018-20: Apply the amendments to all new and existing leases using the effective date and transition requirements in ASU 2016-02 (for example, January 1, 2019, for calendar-year-end public business entities).
 
Entities that have adopted ASC 842 before the issuance of ASU 2018-20: Apply the amendments to all new and existing leases as follows:

1. Apply the amendments:

   1. At the original effective date of ASC 842 for the entity,

   2. In the first reporting period ending after ASU 2018-20’s issuance (for example, December 31, 2018), or

   3. In the first reporting period beginning after ASU 2018-20’s issuance (for example, January 1, 2019).

That is, entities will select one of these three alternatives.

2. Apply the amendments either retrospectively or prospectively.