As companies continue to face challenges preparing to implement the new lease accounting standards, the Financial Accounting Standards Board (FASB) has issued Accounting Standards Update (ASU) 2018-11 (the Update), which provides relief in two specific areas.
Transition Method
First, the amendments in the Update provide an optional transition method that permits entities to initially apply the new lease standard at the adoption date and recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. This method is in addition to the existing modified retrospective transition method, in which an entity initially applies the new lease standard at the beginning of the earliest period presented in the financial statements. Entities electing this additional transition method must provide the required Topic 840 (Leases) disclosures for all periods that continue to be in accordance with Topic 840.
Separating Components of a Contract
Second, the Update provides lessors with a practical expedient, by class of underlying asset, to not separate nonlease components (such as maintenance services) from the associated lease component, but rather account for each separate lease component and the nonlease components associated with that lease component as a single component if the nonlease components otherwise would be accounted for under Topic 606 on revenue from contracts with customers and both of the following are met:
The timing and pattern of transfer for the lease component and nonlease components associated with that lease component are the same.
The lease component, if accounted for separately, would be classified as an operating lease.
If the nonlease component or components associated with the lease component are the predominant component of the combined component, an entity is required to account for the combined component in accordance with Topic 606. If not, the entity must account for the combined component as an operating lease in accordance with Topic 842. Judgment will need to be used to determine the predominant component.
Lessees were already provided with this practical expedient as a policy election, although a. and b. above pertain to lessors only. A lessee’s combined component must always be accounted for under Topic 842.
An entity electing this practical expedient (including an entity that accounts for the combined component entirely in Topic 606) is required to disclose the following by class of underlying asset:
- The fact that it elected the expedient.
- Which class(es) of underlying assets the lessor made the election to.
- The nature of (a) the lease component and nonlease component(s) that were combined as a result of applying the practical expedient and (b) any nonlease components that were not eligible for the practical expedient and, thus, not combined.
- The Topic the entity applied to the combined component (Topic 606 or Topic 842).
Effective Date
The amendments in this Update related to separating components of a contract affect the amendments in Update 2016-02, which are not yet effective but can be adopted early.
For entities that have not adopted Topic 842 before the issuance of this Update, the effective date and transition requirements for the amendments in this Update related to separating components of a contract are the same as the effective date and transition requirements in Update 2016-02 (fiscal years beginning after December 15, 2018 (calendar 2019) for public companies and fiscal years beginning after December 15, 2019 (calendar 2020) for nonpublic companies).
For entities that have adopted Topic 842 before the issuance of this Update, the transition and effective date of the amendments related to separating components of a contract in this Update are as follows:
The practical expedient may be elected either in the first reporting period following the issuance of this Update or at the original effective date of Topic 842 for that entity.
The practical expedient may be applied either retrospectively or prospectively.
All entities, including early adopters, that elect the practical expedient related to separating components of a contract in this Update must apply the expedient, by class of underlying asset, to all existing lease transactions that qualify for the expedient at the date elected.
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