The FASB issued Accounting Standards Update (ASU) No. 2018-20, Leases (ASC 842): Narrow-Scope Improvements for Lessors, to simplify three parts of ASC 842 for lessors. The ASU is available here. It has the same effective dates and transition requirements as ASU No. 2016-02, Leases (ASC 842) except for entities that have already adopted the new lease standard.
The amendments in ASU 2018-20 make targeted improvements for lessors in the following three specific areas:
- Sales Taxes and Other Similar Taxes Collected from Lessees
- Certain Lessor Costs
- Recognition of Variable Payments for Contracts with Lease and Nonlease Components
Sales Taxes and Other Similar Taxes Collected from Lessees
Will this apply to you? The answer depends on whether you are a lessor and are leasing assets in multiple jurisdictions. Prior to ASU 2018-20, ASC 842 required lessors to analyze sales taxes and other similar taxes on a jurisdiction-by-jurisdiction basis to determine whether those taxes are a lessor cost because the lessor is the primary obligor (in which case those taxes should be reported gross in the income statement), or a lessee cost (in which case the lessor is acting as an agent of the lessee and the taxes are therefore not reported in the income statement).
Lessor stakeholders noted that the requirement to analyze those taxes on a jurisdiction-by-jurisdiction basis is costly and complex, considering the number of jurisdictions to evaluate and variations in tax laws. That requirement also produced limited benefits, i.e., a net effect of zero in the income statement.
Amendments in ASU 2018-20: Now, lessors will have an accounting policy election similar to the option in ASC 606, (see ASC 606-10-32-2A). Lessors making this election will:
- Exclude sales and similar taxes from the consideration in the contract and from variable payments not included in the consideration in the contract
- Account for those costs as if they are lessee costs
- Provide certain disclosures under ASC 842-30-50-14.
Lessors electing this accounting policy will report sales and similar taxes on the balance sheet as payments are received/made instead of within the income statement.
Taxes assessed on a lessor’s gross receipts or on the lessor as owner of the underlying asset (for example, property taxes) are excluded from the scope of this lease accounting policy.
Certain Lessor Costs
Will this apply to you? The answer depends on whether you are a lessor with net lease structures. Prior to ASU 2018-20, ASC 842 required lessors to report lessor costs paid by lessees in the income statement on a gross basis, regardless of whether the lessee paid those lessor costs directly to third-parties or reimbursed the lessor. Examples of such lessor costs include property taxes and insurance.
This requirement is costly, complex and potentially misleading, particularly for net lease structures. For example, insurance payments made by a lessee directly to an insurance company are impacted by lessee-specific factors and other information that is often not readily available to the lessor. Similar to the sales tax issue, this information has a net effect of zero in the income statement.
Amendments in ASU 2018-20. The amendments require lessors to exclude lessor costs paid by lessees directly to third parties from variable payments. In other words, those amounts are not reported in the lessor’s income statement.
However, ASU 2018-20 requires lessors to report costs paid by the lessor and reimbursed by the lessee as variable payments. These costs are known by the lessor and will be reported on a gross basis in the income statement.
Recognition of Variable Payments for Contracts with Lease and Nonlease Components
Will this apply to you? The answer depends on whether you are a lessor that receives variable payments for contracts with lease and nonlease components. Prior to ASU 2018-20, ASC 842 required lessors to recognize certain variable payments in the income statement when the changes in facts and circumstances on which the payment is based occurs.
Some lessor stakeholders questioned whether that guidance would result in the recognition of revenue in advance of when ASC 606 would otherwise require.
Amendments in ASU 2018-20. The amendments require lessors to allocate (rather than recognize) those variable payments to the lease and nonlease components when the changes in facts and circumstances on which the payment is based occurs. After that allocation, the lessor applies the recognition guidance in ASC 842 for the amounts allocated to the lease component and applies the recognition guidance in other GAAP (typically, ASC 606) for the amounts allocated to the nonlease components.
Effective Date and Transition Requirements
The effective date and transition requirements for ASU 2018-20 are dependent on whether entities already adopted the new lease standard.
Entities that have not adopted ASC 842 before the issuance of ASU 2018-20: Apply the amendments to all new and existing leases using the effective date and transition requirements in ASU 2016-02 (for example, January 1, 2019, for calendar-year-end public business entities).
Entities that have adopted ASC 842 before the issuance of ASU 2018-20: Apply the amendments to all new and existing leases as follows:
- Entities will select one of the three following alternatives to apply the amendments:
- At the original effective date of ASC 842 for the entity;
- In the first reporting period ending after ASU 2018-20’s issuance (for example, December 31, 2018), or
- In the first reporting period beginning after ASU 2018-20’s issuance (for example, January 1, 2019).
- Apply the amendments either retrospectively or prospectively.
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