Authored by Marsha Ackerman
Much of the new lease accounting standard focuses on lessees; however, the latest clarifications, Accounting Standards Update (ASU) 2018-20: Leases (Topic 842): Narrow-Scope Improvements for Lessors, focuses instead on lessors. The FASB looked at three issues that impact lessor accounting: sales taxes and other similar taxes collected from lessees; certain lessor costs; and recognition of variable payments for contracts with lease and nonlease components. All of these issues have the potential to impact equipment and property lessors, so let’s break them down.
Sales taxes and other similar taxes collected from lessees
The new lease standard requires entities to examine sales and other similar taxes by jurisdiction and determine whether the lessor is acting as a principal (the lessor has the primary obligation for payment of the tax) or an agent (the lessor collects the tax from the lessee on behalf of a third party). Initially, the standard required different accounting treatment depending on whether the lessor was a principal or an agent; however, concern was expressed that such an analysis seemed to present an undue burden to lessors. As a result, rather than a lessor acting as a principal needing to account for payment of the tax as a lessor cost and include the amount in lease revenue and a lessor acting as an agent excluding the tax from lease revenue, the ASU allows lessor entities to make an accounting policy election to treat sales and other similar taxes as lessee costs and exclude all collection of such taxes from lessees from revenue. This accounting policy election applies to sales, use, value added, and some excise taxes. If elected, the lessor must disclose the accounting policy election along with its description of the accounting policy.
Certain lessor costs
When certain costs incurred by a lessor as the owner of an underlying asset are paid by a lessee—either directly to a third party on behalf of the lessor or as a reimbursement to a lessor—the new lease accounting standard requires lessors to report these costs as both revenue and expenses. Concern was expressed about the cost and complexity to the lessor of determining such costs when paid by a lessee directly to a third party. Even if such information were made available to the lessor, questions arose as to the reliability of such information. As a result, the ASU requires lessors to exclude from variable payments (i.e. revenue) lessor costs paid by a lessee directly to a third party. In addition, the ASU clarifies that costs reimbursed to the lessor by a lessee should be considered variable payments and, therefore, excluded from contract consideration.
Recognition of variable payments for contracts with lease and nonlease components
Accounting Standards Codification (ASC) 842 requires lessors to recognize certain variable payments in income in the period in which changes in the facts and circumstances to which the variable payments relate become known. This requirement may lead to revenue related to nonlease components being recognized in advance of when the nonlease component is satisfied under other guidance. As a result, the ASU alters the requirement with regard to changes in facts and circumstances that impact variable payments such that allocation of the variable payment, not recognition of the variable payment, occurs when changes in facts and circumstances become known. This change will prevent circumstances in which variable consideration related to a nonlease component could be recognized in advance of the remaining consideration allocated to that nonlease component.
When are these changes effective?
For lessors that have not yet adopted the new lease accounting standard, the ASU will be effective upon adoption of ASC 842. If an entity has already early-adopted the new lease standard, the lessor has a choice of whether to retrospectively or prospectively apply these changes as outlined within the ASU.
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