It's to be expected that a major new standard like ASC 842 will leave some issues hanging. Since it was released a year and a half ago, the FASB has fielded numerous questions from accountants and corporations about how to implement various aspects of the standard. While some of the questions can be handled informally, the Board felt the need for authoritative guidance on a number of issues. Accordingly, it released on Sep. 27, 2017, a proposed update, covering both ASC 825 (Financial Instruments) and ASC 842 (Leases). In keeping with the FASB's standard due process procedures, these are being released as an exposure draft; comments are open until November 13. Topics (aside from simple editing fixes) include:
Rate Implicit in the Lease
It is proposed to clarify that the implicit rate cannot be less than zero. The problem arises particularly with leases that have a large variable payment component, where the base rent plus unguaranteed residual may be less than the value of the underlying asset. In such a situation, a lessor would be required to recognize a selling loss at the start of the lease. Income would then be recognized during the lease life as the variable payments are made.
Lessee Reassessment of Lease Classification
When a lease is modified, lease classification is reassessed based on the terms, conditions, and circumstances at the time of modification. Some stakeholders were unclear whether this reassessment also applied if an option was exercised. The proposal would make clear that an option exercise is treated the same as other lease modifications, and reassessment is based on the current status.
Lessor Reassessment of Lease Term and Purchase Option
The proposal clarifies that if an option to extend, terminate, or purchase is already recognized, exercise of the option is not treated as a modification.
Variable Lease Payments That Depend on an Index or a Rate
Language would be clarified that adjustments to a rate or index used to calculate variable lease payments (VLPs) do not consitute the "resolution of a contingency" which causes a lease to be remeasured as a modification (because what was previously considered VLPs now becomes regular payments). VLPs that depend on an index or rate do not become part of the base rent, included in the asset and liability, unless there is a separate modification of the lease (such as the exercise of an option that was not previously recognized as part of the lease term).
If an entity doesn't elect the package of practical expedients in ASC 842-10-65-1(f), then any unamortized initial direct costs that were incurred before the start of the first comparative period (i.e., the date as of which ASC 842 calculations start once ASC 842 is implemented, or January 2017 for calendar-year filers) would be written off to equity, while such costs incurred after the start of the first comparative period would be charged to earnings in the period incurred.
Impairment of Net Investment in the Lease
A lessor calculates the net investment by calculating the "collateral" on the investment, which currently is defined as cash flows from the underlying asset during the remaining portion of the lease term. The proposal would add that this includes expected cash flows that may not be realized until after the end of the lease term, such as when the asset is sold.
Unguaranteed Residual Asset
If a lessor sells substantially all of the lease receivable associated with a direct financing or sales-type lease, accretion of the unguaranteed residual asset should stop, as is current practice under ASC 842 (FAS 13). ASC 842 currently refers to "all" rather than "substantially all" of the lease receivable.
There are other changes that are similarly of a clean-up nature, and I would expect they will all be non-controversial. The amendments would be effective immediately upon adoption for entities that have already adopted ASC 842; for those who have not, they would be effective whenever they adopt ASC 842. All are welcome to comment on the proposal via an electronic feedback form (or by mailing/emailing the FASB as detailed in the draft).
A separate proposed update was issued Sep. 25, offering a practical expedient for transition to ASC 842 for land easement.
A new optional practical expedient is proposed that would allow lessees who do not currently treat land easements as leases to maintain such treatment for existing easements. New easements entered into (or modified) after the effective date for ASC 842 will need to be tested to see if they meet the definition of a lease. The proposal also clarifies that the determination of whether a land easement is a lease under ASC 842 happens before applying the ASC 350 guidance on intangible assets. This expedient would provide substantial relief to entities such as utilities who may have large numbers of easements.
The comment period ends Oct. 25; again, comments can be by mail/email or by electronic feedback form.