The Financial Accounting Standards Board (FASB) on July 30 issued an “Accounting Standards Update (ASU) 2018-11, Leases (Topic 842): Targeted Improvements” that aims to reduce costs and ease implementation of the lease accounting standard for financial statement purposes.

The ASU simplifies transition requirements and, for lessors, provides a practical expedient, by class of underlying asset, to non-lease components from the associated lease components.

Specifically, the ASU provides:

• An option to apply the transition provisions of the new standard at its adoption date instead of at the earliest comparative period presented in its financial statements; and
• A practical expedient that permits lessors to not separate non-lease components from the associated lease component if certain conditions are met.

The (FASB) Accounting Standards Codification (ASC) 842, issued in 2016, will have a significant impact on how businesses manage, account for and report substantially all leases, including equipment and real estate. Because of the meaningful accounting changes involved, it’s important businesses begin preparing now to comply with the new standards. Topic 842 will require entities who lease assets—referred to as “lessees”—to recognize, on their balance sheet, the assets and liabilities for the rights and obligations created by those leases with terms greater than one year.

Topic 842 requires public companies to include all leases with terms greater than one year on their balance sheet for annual and interim reporting periods beginning after December 15, 2018 (Effective Date). The private company Effective Date provides a one-year deferral, December 15, 2019, for annual reporting periods and interim periods the following year. Early adoption is also permitted for all entities.

Transition Method

The ASU provides entities with an additional (and optional) transition method to adopt the new leases standard. Under this new transition method, an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained
earnings in the period of adoption consistent with preparers’ requests.

Consequently, an entity’s reporting for the comparative periods presented in the financial statements in which it adopts the new leases standard will continue to be in accordance with current GAAP (Topic 840, Leases). An entity that elects this additional (and optional) transition method must provide the required Topic 840 disclosures for all periods that continue to be in accordance with Topic 840. The amendments do not change the existing disclosure requirements in Topic 840 (for example, they do not create interim disclosure requirements that entities previously were not required to provide).

Separating Components of a Lease Contract

The ASU provides lessors with a practical expedient, by class of underlying asset, to not separate non-lease components from the associated lease component and, instead, to account for those components as a single component if the non-lease components otherwise would be accounted for under the new revenue guidance (Topic 606) and both of the following are met:

1. The timing and pattern of transfer of the non-lease component(s) and associated lease component are the same.
2. The lease component, if accounted for separately, would be classified as an operating lease.

In May 2014, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) initiated a joint effort for recognizing revenue from contracts with customers, Accounting Standards Update 2014-09 (Topic 606), “Revenue from Contracts with Customers” (affecting Accounting Standards Codification (ASC) 606) and International Financial Reporting Standards (IFRS) 15. The guidance aims to improve revenue reporting by providing a framework for addressing issues, to improve comparability between industries and capital markets and to provide useful information for financial statements and disclosures.

If the non-lease component or components associated with the lease component are the predominant component of the combined component, an entity is required to account for the combined component in accordance with Topic 606. Otherwise, the entity must account for the combined component as an operating lease in accordance with Topic 842.

An entity electing this practical expedient (including an entity that accounts for the combined component entirely in Topic 606) is required to disclose the following by class of underlying asset:

1. The fact that it elected the expedient
2. Which class(es) of underlying asset the lessor made the election to
3. The nature of (a) the lease component and non-lease component(s) that were combined as a result of applying the practical expedient and (b) any non-lease components that were not eligible for the practical expedient and, thus, not combined
4. The Topic the entity applies to the combined component (Topic 606 or Topic 842).

Elective Timeline Changes

The amendments in the ASU related to separating components of a contract affect the amendments in Update 2016-02, which are not yet effective, but can be early adopted.

For entities that have not adopted Topic 842 before the issuance of this update, the effective date and transition requirements for the amendments in this update related to separating components of a contract are the same as the effective date and transition requirements in Update 2016-02.

For entities that have adopted Topic 842 before the issuance of this update, the transition and effective date of the amendments related to separating components of a contract in this update are as follows:

1. The practical expedient may be elected either in the first reporting period following the issuance of this update or at the original effective date of Topic 842 for that entity.
2. The practical expedient may be applied either retrospectively or prospectively.

All entities, including early adopters, that elect the practical expedient related to separating components of a contract in this update must apply the expedient, by class of underlying asset, to all existing lease transactions that qualify for the expedient at the date elected.