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Standards Update: 8/11/21

August 11, 2021

The Financial Accounting Standards Board (FASB) regularly issues Accounting Standards Updates (ASUs) to make changes to the FASB Codification, the primary source of Accounting Principles Generally Accepted in the United States (GAAP). Below is an ASU that was recently issued.

ASU No. 2021-05, Leases (Topic 842): Lessors ‒ Certain Leases with Variable Lease Payments

The Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) No. 2021-05, Leases (Topic 842): Lessors ‒ Certain Leases with Variable Lease Payments to address issues identified in the application of Accounting Standards Codification (ASC) 842 for lease contracts with significant variable lease payments classified as sales-type or direct financing leases.

Summary

A lessor is required to determine whether a lease is classified as a sales-type or direct financing lease at lease commencement, based on specified criteria. Under current guidance in ASC 842, lessors must exclude variable lease payments that do not depend on a reference index or a rate when determining the lease receivable for sales-type and direct financing leases. The exclusion of these variable lease payments may result in an initial entry with a loss upon derecognition of the underlying asset, because the net investment in the lease is less than the book value of the underlying asset prior to derecognition. Generally, the recognition of a loss at the commencement of a lease would not properly reflect the underlying economics of the transaction.

The amendments in ASU No. 2021-05 require a lessor to classify a lease with variable lease payments that do not depend on an index or a rate as an operating lease at lease commencement if classifying the lease as a sales-type lease or a direct financing lease would result in the recognition of a selling loss. As an operating lease, no loss would be recorded at lease commencement, because a lessor does not recognize a net investment in the lease and does not derecognize the underlying asset.

ASU No. 2021-05 has no impact on lessee accounting.

Effective Date and Transition

ASU No. 2021-05 is effective for all entities for fiscal years beginning after Dec. 15, 2021. Early adoption is permitted.

Entities that have not yet adopted ASC 842 on or before the issuance date of the ASU (July 19, 2021) should apply the transition guidance for the adoption of ASC 842, which provides for either retrospective application to each prior period presented in the financial statements with the cumulative effect adjustment at the beginning of the earliest period presented or retrospective application to the beginning of the period of adoption with a cumulative effect adjustment recognized at the beginning of that period.

Entities that have adopted ASC 842 before the issuance date of the ASU may apply the amendments either retrospectively to leases that commenced or were modified on or after the adoption of ASU 2016-02, Leases (Topic 842) or prospectively to leases that commence or are modified on or after the date of adoption of this ASU.

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