On July 30, 2018, the FASB issued a greatly anticipated ASU related to the new lease standard. ASU 2018-11, Leases (Topic 842), Targeted Improvements, has two provisions that are intended to make transition to the new lease standard easier and less costly. One is an additional transition method, providing transition relief that will be of great interest to lessees and lessors. The other provides a new practical expedient for lessors in their identification and separation of lease components.
Additional Transition Method
ASU 2018-11 provides an optional method that greatly simplifies transition to the new lease standard. As it was originally written, the new lease standard required adoption using a modified retrospective transition method as of the first date reflected on the financial statements. This additional transition method permits entities to use the effective date of the new lease standard as the date of initial application. For example, most privately held companies with a calendar year end can use January 1, 2021 as their Initial Application Date (updated 10/16 per FASB delay decision).
With this additional transition method, comparative prior year financial statements do not have to be restated. Instead, they will continue to be presented under the current accounting guidelines for leases under ASC 840. A cumulative-effect adjustment is recognized to the opening balance of retained earnings in the period of adoption rather than in the earliest period presented in the financial statements.
In addition, lease disclosures under the new lease standard are not required for periods before the effective date. The lease disclosures for prior years presented in comparative financial statements under ASC 840 are presented in accordance with ASC 840, carried forward from prior year statements, rather than under ASC 842.
The following example illustrates election of the transition option for a calendar year entity that adopts the standard on January 1, 2021 and presents comparative financial statements for 2020:
Elects New Transition Option Does Not Elect
Date to apply transition provisions 1/1/2021 (effective date) 1/1/2020
Date to present right to use assets 1/1/2021 1/1/2020
and related lease liabilities
Cumulative effect adjustment 1/1/2021 1/1/2020
to Retained Earnings as of
Required to restate prior year No Yes
comparative financial statements?
Presentation of leases in ASC 840 ASC 842
comparative financial statements
Prior year lease disclosures ASC 840 ASC 842
Current year lease disclosures ASC 842 ASC 842
While this additional transition method allows organizations to not restate prior periods, the modified transition approach must still be applied upon adoption. Even with that, this additional transition method can significantly reduce the cost and complexity of implementing the new lease standard for organizations with comparative prior periods in the year of adoption.
Separation of Components for Lessors
ASU 2018-11 contains a new practical expedient that allows lessors to elect not to separate lease components from nonlease components within a contract but instead to account for them as a single component. This practical expedient can only be elected if both of the following conditions are met:
The lease component, if accounted for separately, would be classified as an operating lease.
The timing and pattern of transfer/revenue recognition for the lease and nonlease components are the same.
The FASB made this change to address concerns that were raised by implementers about the difficulty of determining standalone selling prices for lease and nonlease components that are not sold separately and about the relevance of information about separate components to financial statement users.
Prior guidance in the new lease standard required that lessors always separate and allocate consideration in the contract to lease and nonlease components. Once separated, the nonlease components would be accounted for and disclosed in accordance with ASC 606, Revenue From Contracts With Customers, and the lease components would be accounted for and disclosed based on the new lease standard. The practical expedient for lessees in ASC 842-10-15-37 to elect not to separate nonlease from lease components was not available to lessors.
Lessors will have to apply judgment to determine which of the components is predominant – that is, the component that is expected to have more value. When combined using the practical expedient, if the nonlease component is the predominant component, the accounting will follow ASC 606. If the nonlease component is not predominant, then the single component is accounted for as an operating lease under the new lease standard.
The new practical expedient must be applied consistently, as an accounting policy by class of underlying asset. For nonlease components that do not qualify for the practical expedient, lessors will allocate consideration to those components on a relative standalone selling price basis and account for them based on ASC 606.
For lessors that elect this practical expedient, the following new disclosures are required: that the expedient was elected; which asset classes the election applies to; the nature of the items that are being combined along with any nonlease components that were not eligible and were not combined; and the accounting guidance applied to the combined component (ASC 606 or 842). The ASU has the same effective date as the new lease standard.
The FASB’s new guidance may impact adoption decisions. Although the new lease standard doesn’t go into effect until 2019/2021, CPA firms and their clients should discuss all elements of their leases because required decisions impact both the transition and day one accounting. For additional information about how LeaseCrunch® can support you as you talk to your clients about the impact of the new standard and what they should be doing to prepare now, contact us today.