Appendix H
The New Leases Standard: FASB ASC 842
This appendix is nonauthoritative and is included for informational purposes only.
Overview
Issuance and Objective
On February 25, 2016, FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842). The objective of the ASU is to increase transparency and comparability in financial reporting by requiring balance sheet recognition of leases and note disclosure of certain information about lease arrangements. This ASU codifies the new FASB Accounting Standards Codification (ASC) topic 842, Leases, and makes conforming amendments to other FASB ASC topics.
The new FASB ASC topic on leases consists of these subtopics:
a. Overall
b. Lessee
c. Lessor
d. Sale and leaseback transactions
e. Leveraged lease arrangements
Applicability and Effective Date
ASU No. 2016-02 is applicable to any entity that enters into a lease and is effective as follows:
| Fiscal Years Beginning After | Interim Periods Within Fiscal Years Beginning After | |
| Public business entities, certain not-for-profit entities with conduit financing arrangements, and employee benefit plans | December 15, 2018 | December 15, 2018 |
| All other entities | December 15, 2019 | December 15, 2020 |
FASB ASC 842 applies to all leases and subleases of property, plant, and equipment; it specifically does not apply to the following nondepreciable assets accounted for under other FASB ASC topics:
a. Leases of intangible assets
b. Leases to explore for or use nonregenerative resources such as minerals, oil, and natural gas
c. Leases of biological assets, such as timber
d. Leases of inventory
e. Leases of assets under construction
Transition
FASB ASC 842-10-65-1 describes the requirements for financial statement presentation when an entity first applies the guidance. Leases that exist at the application date and within the scope of FASB ASC 842 should be recognized and measured using the appropriate approach described in FASB ASC 842-10-65-1 items (a)–(ee), which address the following:
• Transition methods
— Retrospective application to each prior reporting period presented in the financial statements with the cumulative effect of initial application recognized at the beginning of the earliest comparative period presented (subject to other transition requirements). Under this transition method, the application date should be the later of the beginning of the earliest period presented in the financial statements and the commencement date of the lease.
— Retrospective application at the beginning of the period of adoption through a cumulative-effect adjustment (subject to other transition requirements). Under this transition method, the application date should be the beginning of the reporting period in which the entity first applies the guidance.
• Disclosure
— Transition disclosures required by FASB ASC 250, Accounting Changes and Error Corrections
— Use of practical expedient(s), if applicable
• Lessees
— Leases previously classified under FASB ASC 840, Leases, as operating leases and capital leases
— Build-to-suit lease arrangements
• Lessors
— Leases previously classified under FASB ASC 840 as operating leases, direct financing or sales-type leases, and leveraged leases
— Sale and leaseback transactions before the effective date
Transition disclosures are illustrated in paragraphs 243–254 of FASB ASC 842-10-55.
Main Provisions
Overall
Identifying a Lease
Key changes in the guidance are illustrated by comparing the definition of a lease in FASB ASC 840 (extant GAAP) and FASB ASC 842.
| FASB ASC 840 | FASB ASC 842 |
| An agreement conveying the right to use property, plant, or equipment (land and/or depreciable assets) usually for a stated period of time. | A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration. |
The identification of a lease under FASB ASC 842 should be based on the presence of key elements in the definition.
Separating Components of a Lease Contract
Under FASB ASC 842, a contract that contains a lease should be separated into lease and nonlease components. Separation should be based on the right to use; each underlying asset should be considered to be separate from other lease components when both of the following criteria are met:
a. The lessee can benefit from the right-of-use of the asset (either alone or with other readily available resources)
b. The right-of-use is neither highly dependent on or highly interrelated with other underlying assets in the contract
The consideration in the contract should be allocated to the separate lease and nonlease components in accordance with provisions of FASB ASC 842.
Lessees can make an accounting policy election to treat both lease and nonlease elements as a single lease component.
Lease Classification
When a lease meets any of the following specified criteria at commencement, the lease should be classified by the lessee and lessor as a finance lease and a sales-type lease, respectively. These criteria can be summarized as follows:
a. Transfers ownership to lessee
b. Purchase option reasonably certain to be exercised
c. Lease term for major portion of asset’s remaining economic life
d. Present value of lease payments and residual value exceeds substantially all of the fair value of the underlying asset
e. Specialized nature of underlying asset results in no expectation of alternative use after the lease term
If none of the preceding criteria are met, the lease should be classified as follows:
Lessee — classify as an operating lease
Lessor — classify as an operating lease unless (1) the present value of the lease payments and any residual value guarantee that equals or exceeds substantially all of the fair value of the underlying asset and (2) it is probable that the lessor will collect the lease payments plus any residual value guarantee. If both of these summarized criteria from FASB ASC 842-10-25-3 are met, the lessor should classify the lease as a direct financing lease.
Lease Term and Measurement
The lease term is the noncancellable period of the lease together with all of the following:
a. Period covered by the option for the lessee to extend the lease if the option is reasonably certain to be exercised
b. Period covered by option for lessee to terminate the lease if reasonably certain not to be exercised
c. Period covered by option for lessor to extend or not terminate the lease if option is controlled by lessor.
Lease Payments
Lease payments relating to use of the underlying asset during the lease term include the following at the commencement date:
a. Fixed payments less incentives payable to lessee
b. Variable lease payments based on an index or other rate
c. Exercise price of an option to purchase the underlying asset if it is reasonably certain to be exercised
d. Payments for penalties for terminating a lease if the lease term reflects exercise of lessee option
e. Fees paid by the lessee to the owners of a special purpose entity for structuring the lease
f. For lessee only, amounts probable of being owed under residual value guarantees
Lease payments specifically exclude the following:
a. Certain other variable lease payments
b. Any guarantee by the lessee of the lessor’s debt
c. Certain amounts allocated to nonlease components
Reassessment of the lease term and purchase options, and subsequent remeasurement by either the lessee or lessor are limited to certain specified circumstances.
Lessee
Recognition and Measurement
Commencement Date
At the commencement date of the lease, a lessee should recognize a right-of-use asset and a lease liability; for short term leases, an alternative accounting policy election is available.
The lease liability should be measured at the present value of the unpaid lease payments. The right-of-use asset should consist of the following: the amount of the initial lease liability; any lease payments made to lessor at or before the commencement date minus any incentives received; and initial direct costs.
A short term lease is defined by the FASB ASC master glossary as a lease that, at the commencement date has a lease term of 12 months or less and does not include an option to purchase the underlying asset that the lessee is reasonably certain to exercise. The accounting policy election for short term leases should be made by class of underlying asset. The election provides for recognition of the lease payments in profit or loss on a straight-line basis over the lease term and variable lease payments in the period in which the obligation for those payments is incurred.
After the Commencement Date
After the commencement date, the lessee should recognize in profit or loss (unless costs are included in the carrying amount of another asset) the following:
• Finance leases:
- a. Amortization of the right-of-use asset and interest on the lease liability
- b. Variable lease payments not included in the lease liability in the period obligation incurred
- c. Any impairment
• Operating leases:
- a. A single lease cost calculated such that the remaining cost is allocated on a straight line basis over the remaining lease term (unless another allocation is more representative of the benefit from use of the asset)
- b. Variable lease payments not included in the lease liability in the period in which the obligation is incurred
- c. Any impairment
Subsequent Measurement
FASB ASC 842-20-35 provides guidance for subsequent measurement.
Presentation and Disclosure
Key presentation matters include the following:
• Statement of financial position.
— Separate presentation of right-of-use assets and lease liabilities from finance leases and operating leases.
• Statement of comprehensive income.
— Finance leases — interest expense on the lease liability and amortization of right-of-use asset in a manner consistent with how the entity presents other interest expense and depreciation or amortization of similar assets.
— Operating leases — expense to be included in the lessee’s income from continuing operations.
• Statement of cash flows.
— Presentation within financing activities — the repayment of the principal portion of the lease liability arising from finance leases.
— Presentation within operating activities — payments arising from operating leases; interest payments on the lease liability; variable lease payments and short term lease payments not included in lease liability.
Disclosure requirements include qualitative and quantitative information for leases, significant judgements, and amounts recognized in the financial statements, including certain specified information and amounts.
Lessor
Recognition and Measurement
FASB ASC 842 provides recognition guidance for sales-type leases, direct financing leases, and operating leases. The following table summarizes the guidance:
| Sales-Type Leases | |
| At the Commencement Date | After the Commencement Date |
| Lessor should derecognize the underlying asset and recognize the following:
a. Net investment in the lease (lease receivable and unguaranteed residual asset) b. Selling profit or loss arising from the lease c. Initial direct costs as an expense |
Lessor should recognize all of the following:
a. Interest income on the net investment in the lease b. Certain variable lease payments c. Impairment |
| Direct Financing Leases | |
| At the Commencement Date | After the Commencement Date |
| Lessor should derecognize the underlying asset and recognize the following:
a. Net investment in the lease (lease receivable and unguaranteed residual asset reduced by selling profit) b. Selling loss arising from the lease, if applicable |
Lessor should recognize all of the following:
a. Interest income on the net investment in the lease b. Certain variable lease payments c. Impairment |
| Operating Leases | |
| At the Commencement Date | After the Commencement Date |
| Lessor should defer initial direct costs. | Lessor should recognize all of the following:
a. The lease payments as income in profit or loss over the lease term on a straight line basis (unless another method in more representative of the benefit received) b. Certain variable lease payments as income in profit or loss c. Initial direct costs as an expense over the lease term on the same basis as lease income |
FASB ASC 842-30-35 provides guidance for subsequent measurement.
Presentation and Disclosure
Key presentation matters include the following:
For sales-type and direct financing leases:
• Statement of financial position
— Separate presentation of lease assets (that is, aggregate of lessor’s net investment in sales-type leases and direct financing leases) from other assets.
— Classified as current or noncurrent based on same considerations as other assets.
• Statement of comprehensive income
— Presentation of income from leases in the statement of comprehensive income or disclosure of income from leases in the notes with a reference to the corresponding line in the statement of comprehensive income.
— Presentation of profit or loss recognized at commencement date in a manner appropriate to lessor’s business model.
• Statement of cash flows
— Presentation within operating activities — cash receipts from leases.
For operating leases:
• Statement of financial position
— Presentation of an underlying asset subject to an operating leases in accordance with other FASB ASC topics.
• Statement of cash flows
— Presentation within operating activities — cash receipts from leases.
Disclosure requirements include qualitative and quantitative information for leases, significant judgements, and amounts recognized in the financial statements, including certain specified information and amounts.
Sale and Leaseback Transactions
FASB ASC 842 provides guidance for both the transfer contract and the lease in a sale and leaseback transaction (a transaction in which a seller-lessee transfers an asset to a buyer-lessor and leases that asset back). Determination of whether the transfer is a sale should be based on provisions of FASB ASC 606, Revenue from Contracts with Customers. FASB ASC 842-40-25 provides measurement guidance for a transfer that is either determined to be a sale or determined not to be a sale.
FASB ASC 842-40 provides guidance for subsequent measurement, financial statement presentation, and disclosures.
Leveraged Lease Arrangements
The legacy accounting model for leveraged leases continues to apply to those leveraged leases that commenced before the effective date of FASB ASC 842. There is no separate accounting model for leveraged leases that commence after the effective date of FASB ASC 842.
Subsequent Developments
ASU No. 2018-01
In January 2018, FASB issued ASU No. 2018-01, Leases (Topic 842): Land Easement Practical Expedient for Transition to Topic 842. This ASU permits an entity to elect an optional transition practical expedient to not evaluate under FASB ASC 842 existing or expired land easements not previously accounted for as leases under FASB ASC 840.
Effective Date
The effective date of FASB ASU No. 2018-01 is in line with the guidance in ASU No. 2016-02.
ASU No. 2018-10
In July 2018, FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases. The amendments in this ASU affect narrow aspects of FASB ASC 842 and address the following sixteen specific areas for improvement:
1. Residual Value Guarantees
2. Rate Implicit in the Lease
3. Lessee Reassessment of Lease Classification
4. Lessor Reassessment of Lease Term and Purchase Option
5. Variable Lease Payments That Depend on an Index or a Rate
6. Investment Tax Credits
7. Lease Term and Purchase Option
8. Transition Guidance for Amounts Previously Recognized in Business Combinations
9. Certain Transition Adjustments
10. Transition Guidance for Leases Previously Classified as Capital Leases under Topic 840
11. Transition Guidance for Modifications to Leases Previously Classified as Direct Financing or Sales-Type Leases under Topic 840
12. Transition Guidance for Sale and Leaseback Transactions
13. Impairment of Net Investment in the Lease
14. Unguaranteed Residual Asset
15. Effect of Initial Direct Costs on Rate Implicit in the Lease
16. Failed Sale and Leaseback Transaction
Effective Date
For entities that have not early adopted FASB ASC 842, the effective date and transition requirements are the same as ASU No. 2016-02. For entities that early adopted FASB ASC 842, the amendments were effective upon issuance of the ASU.
ASU No. 2018-11
In July 2018, FASB issued ASU No. 2018-11, Leases (Topic 842) Targeted Improvements. The amendments in this ASU can be organized into the following two areas:
1. Transition — Comparative Reporting at Adoption
2. Separating Components of a Contract
Transition — Comparative Reporting at Adoption
The amendments to transition guidance related to comparative reporting at adoption apply to all entities with lease contracts that choose the additional transition method provided by this ASU.
This ASU amends FASB ASC 842-10-65-1 to permit an entity to elect an optional transition method to initially apply the new leases standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption.
This ASU also amends FASB ASC 842-10-65-1 related to the optional transition method for the following:
• Disclosure
• Lessees with leases previously classified under FASB ASC 840 as
— Operating leases
— Capital leases
— Build-to-suit lease arrangements
• Lessors with leases previously classified under FASB ASC 840 as
— Operating leases
— Direct financing leases
— Sales-type leases
— Sale and leaseback transactions before the effective date
Separating Components of a Contract
The amendments related to separating components of a contract apply only to lessors whose lease contracts qualify for the practical expedient provided by this ASU.
This ASU amends FASB ASC 842-10-15-42 to permit lessors to use a practical expedient, by class of underlying asset, to not separate nonlease components from the associated lease component and, instead, to account for those components as a single component if the nonlease components otherwise would be accounted for under FASB ASC 606 and both of the following conditions are met: (1) The timing and pattern of transfer of the nonlease component(s) and associated lease component are the same, and (2) the lease component, if accounted for separately, would be classified as an operating lease.
This ASU makes related amendments to FASB ASC 842 that affect the implementation guidance and illustrations in the subtopic “Overall” and the disclosure requirements in the subtopic “Lessors.”
Effective Date
The effective dates are as follows:
• For entities that have not adopted FASB ASC 842 before the issuance of this ASU, the effective date and transition requirements are the same as the those in ASU No. 2016-02. Amendments in ASU No. 2016-02 are not yet effective but can be early adopted.
• For entities that have adopted FASB ASC 842 before the issuance of this ASU, the election and application of the practical expedient is specified in the ASU.
All entities electing the practical expedient should apply the guidance by class of underlying asset to all existing lease transactions that qualify for the expedient at the date elected.
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