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Public Companies Catch a Break with Leasing Standard Update

Aug. 7, 2018

The Financial Accounting Standards Board (FASB) recently issued guidance to make transitioning to and applying the new leasing standard easier. Accounting Standards Update 2018-11, Leases (Topic 842) Targeted Improvements (ASU 2018-11) addresses questions related to the initial adoption of the standard in comparative periods, and for lessor accounting, separating lease and nonlease components of a contract. Changes to the adoption requirements will be particularly important for SEC filers as they prepare their third and fourth quarter filings.

Comparative Reporting Changes

As originally issued in ASU 2016-02, Leases (Topic 842), entities must use a modified retrospective transition when adopting the new leasing standard. This method required entities to apply to changes to the earliest financial period presented in the financial statements in the year of adoption.

Public companies that follow a calendar year reporting schedule must adopt the leasing standard starting Jan. 1, 2019. Private companies following a calendar year reporting schedule adopt the new lease guidance for their Dec. 31, 2020 annual financial statements. The modified retrospective transition method originally issued meant that a public company could be required to retroactively apply the lease accounting changes to lease assets and liabilities starting as early as Jan. 1, 2017.

Financial statement preparers encountered some unexpected cost and complexity in following the modified retrospective approach. To reduce the cost and complexity, ASU 2018-11 creates another transition method that companies can elect to use. The new method allows entities to adopt the new standard at the effective date and recognize a cumulative-effective adjustment in the opening balance of retained earnings in the year of adoption (i.e. Jan. 1, 2019 for a public company reporting on a calendar year). When adopting the new method, an entity would no longer be required to retroactively apply the standard to prior periods presented in the financial statements.

Components of a Contract

Leases are separated into lease components and nonlease components under Topic 842. Lessees allocate consideration to lease and nonlease components based on the standalone selling price of those components. Lessors allocate consideration using other accounting standards, such as the new revenue recognition standard under ASC Topic 606, Revenue from Contracts with Customers (Topic 606).

Topic 842 gives lessees an option to elect a practical expedient to lump associated lease and nonlease components together by class of underlying asset. If elected, the lessee would make additional disclosures about the combined component(s). ASU 2018-11 creates a similar practical expedient election for lessors. Lessors will be able to elect to group lease and nonlease components together when the following conditions are met:

  • The nonlease components would be accounted for under Topic 606;
  • The timing and pattern of transfer are the same for the nonlease components as the lease components, and
  • The lease component, if accounted for separately, would be classified as an operating lease.

Changes also clarify that if the nonlease component(s) are the predominant component of the combined lease/nonlease component, the lessor should account for the consideration of the component following the guidance in Topic 606. If the lease component is the predominant component, lessors should account for consideration using the guidance in Topic 842.

Lessors who have implemented the leasing standard early may elect the lease/nonlease component practical expedient for the first reporting period following the release of ASU 2018-11. They may also apply it retroactively. All other lessors can elect the practical expedient when they adopt the new leasing standard.

If elected, lessors must apply the practical expedient by underlying asset class to all lease transactions that qualify for the expedient as of the election date.

Pre-adoption Disclosure

The Securities and Exchange Commission (SEC) has established expectations that publicly traded companies will include pre-adoption disclosures to help users of the financial statements understand how new accounting standards will impact the financial statements once adoption. According to SEC Staff Accounting Bulletin (SAB) Topic 11M, a company should consider pre-adoption disclosures including:

  • A brief description of the new standard, the date that adoption is required and the date that the registrant plans to adopt, if earlier.
  • A discussion of the methods of adoption allowed by the standard and the method expected to be utilized by the registrant, if determined.
  • A discussion of the impact that adoption of the standard is expected to have on the financial statements of the registrant, unless not known or reasonably estimable. In that case, a statement to that effect may be made.
  • Disclosure of the potential impact of other significant matters that the registrant believes might result from the adoption of the standard (such as technical violations of debt covenant agreements, planned or intended changes in business practices, etc.) is encouraged.

Furthermore, as with the run-up to the adoption of Topic 606, the SEC staff has communicated that there is an expectation that the pre-adoption disclosure will become more robust and detailed as the implementation draws near due to the significance of Topic 842. Entities should consider providing additional disclosure to assist the financial statement user in understanding the upcoming impact of adoption of this major accounting standard by providing details regarding quantitative and qualitative aspects, such as:

  • Description of impact
  • Expected changes in accounting policies
  • Status of assessment including aspects not yet addressed, if applicable
  • Quantitative impact, unless not reasonably estimable

With the issuance of ASU 2018-11 public companies can now evaluate and conclude on a method of adoption. Once a transition method has been selected by a company, disclosure of the decision would be appropriate in its filings. In addition to the transition method, lessors should consider whether disclosure about their decision to apply or not apply the practical expedient to combine lease and non-lease components are necessary.

For More Information

MHM will continue to monitor developments related to the leasing standard and provide more information as the guidance becomes available. For specific comments, questions or concerns about the new leasing standard, please contact us.

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