April 16, 2021
The Financial Accounting Standards Board voted to modify its leases standard so some companies won’t have to recognize a heavy loss at the beginning of certain types of lease contracts.
The change, which FASB approved at a board meeting Wednesday, applies to sales-type leases with variable lease payments. The leases standard, also known as ASC 842 under FASB’s Accounting Standards Codification, requires lessors to determine whether a lease should be classified as a sales-type lease at the commencement of a lease on the basis of specific classification criteria. A lessor would be prohibited from including most variable payments in measuring its lease receivable, aside from payments that depend on a reference index or a rate. Subsequently, those excluded variable payments would be recognized entirely as lease income when the changes in facts and circumstances on which those variable payments are based occur.
That means the lease receivable for a sales-type lease with excluded variable payments could be less than the carrying amount of the underlying asset derecognized at the beginning of the lease. As a result, the lessor would recognize a loss at lease commencement, as a day-one loss, even if the lessor expects the arrangement to be profitable overall. Some of FASB’s stakeholders, including Google’s parent company Alphabet, complained in comment letters that recognizing an immediate selling loss for a sales-type lease with variable payments that are excluded from the measurement of the lease receivable would lead to reporting outcomes that didn’t faithfully represent the underlying economics, both at the commencement of a lease and over the term of the lease. They emphasized that this wouldn’t provide users of financial statements with financial information that’s relevant or useful for decisions.
“While most comment letter respondents supported the proposed approach as a practical solution to the issue with recommendations for certain clarifying changes to improve operability of the ‘predominant’ threshold, several respondents recommended that the board consider an alternative approach to address uneconomic day-one losses in sales-type leases even if the payments for that lease are not predominantly variable,” said FASB in a handout for Wednesday’s meeting.
The problem that eventually arose with sales-type leases may have been an unintended consequence of the transition from the old ASC 840 standard to the new ASC 842 standard. “I think what we were trying to do was achieve the objective that we stated in [ASC] 840, which is not to change accounting for lessors,” FASB vice chairman James Kroeker said at the meeting. “The board did not actually debate the issue that caused this problem specifically. We took out a paragraph that people were applying in practice that caused this unintended consequence. We did expose something that said ‘predominantly all’ because we thought that it might be a more operable solution. The board never debated whether it would equally apply to sales-type leases with a day one profit. That wasn’t highlighted in the original deliberation.”
As part of a set of targeted improvements that have been proposed in the leases standard, FASB tentatively decided at the meeting that a lessor should be able to classify a lease with variable lease payments that don’t depend on an index or a rate as an operating lease at lease commencement if the lease would have been classified as a sales-type lease or direct financing lease in accordance with the classification criteria in the standard, and if the lessor would have recognized a selling loss at lease commencement.
Public companies have already begun to adopt the leases standard, but FASB gave private companies and nonprofits more time to adopt it because of the pandemic. All lessors that have not adopted the standard on or before the fiscal years beginning after Dec. 15, 2021, would follow the transition requirements in the standard. Lessors that have adopted the standard on or before the fiscal years starting after Dec. 15, 2021, would have the option to apply the amendments in a final Accounting Standards Update that FASB plans to issue in either of the following ways: They could apply them retrospectively to leases that commence or are modified on or after the adoption of ASC 842; or they could apply the amendments prospectively to leases that commence or are modified on or after the date that a lessor first applies the amendments in a final standards update. Early adoption would be allowed but not before adoption of ASC 842. FASB has directed its staff to draft a new standards update for a vote by written ballot.