BC14. A lessor may incur various costs in its role as a lessor or as owner of the underlying asset (lessor costs), such as the property taxes and insurance costs illustrated in Example 12—Case A of Subtopic 842-10
(paragraphs 842-10-55-141 through 55-142). A requirement for the lessee to pay those lessor costs does not transfer a good or service to the lessee in addition to the right to use the underlying asset. The new leases guidance, therefore, requires that the lessor report those amounts as revenue and expenses (that is, gross) regardless of whether the lessee pays those lessor costs directly to a third party or as a reimbursement to the lessor.
BC15. When payments made by a lessee directly to a third party for lessor costs (on behalf of the lessor) are variable, those payments are not part of the consideration in the contract and would have been accounted for as variable payments subject to the allocation guidance in Topic 842
. That is, the lessor would have allocated those payments to the lease and nonlease components of the contract and recognized the amounts allocated to the lease components in accordance with paragraph 842-10-15-40.
BC16. For certain lessor costs paid directly by lessees to third parties on behalf of the lessor (particularly property taxes and insurance costs related to the leased asset), lessor stakeholders informed the Board about operability challenges in obtaining or otherwise determining those amounts to meet the requirement for including those amounts in the measurement of variable (lease) revenue and related expenses. Lessor stakeholders noted that the costs of complying would be significant and would outweigh the benefits of providing that information primarily because those amounts could be affected by numerous factors, some of which are lessee specific and unknown to the lessor. Determining those amounts often would be challenging and could result in users of financial statements being provided with information that is unreliable. For example, insurance costs paid by a lessee directly to the insurance provider may be affected by numerous factors, some of which are lessee specific, such as deductibles, or when the underlying asset is insured under an umbrella policy.
BC17. Stakeholders requested that the Board provide a practical expedient for lessors to not recognize variable (lease) revenue (and the corresponding cost as an expense) for lessor costs under Topic 842
that are paid directly by the lessee to third parties (Lessee-Paid). Those stakeholders highlighted the following discussions summarized in paragraph BC38(c) of Update 2016-08:
A key tenet of variable consideration is that at some point the uncertainty in the transaction price ultimately will be resolved. When the uncertainty is not expected to ultimately be resolved, the guidance indicates that the difference between the amount to which the entity is entitled from the intermediary and the amount charged by the intermediary to the end customer is not variable consideration and, therefore, is not part of the entity’s transaction price.
BC18. For consistency, those stakeholders stated that if the Board provides a practical expedient to exclude Lessee-Paid costs for the reasons described in paragraph BC16, then the Board also should consider providing a practical expedient for certain lessor costs when those costs are first paid by the lessor and subsequently reimbursed by the lessee to the lessor (Lessee-Reimbursed). They asserted that the economics between Lessee-Paid and Lessee-Reimbursed costs are the same and, therefore, should not result in different financial reporting outcomes. Those stakeholders noted that a practical expedient on Lessee-Reimbursed costs in addition to a practical expedient on Lessee-Paid costs would provide greater consistency among different types of lease arrangements across different entities, thereby providing more meaningful financial reporting for users of the financial statements to appropriately analyze.
BC19. The Board deliberated those requests and added a project that would require (would not permit as an accounting policy election) that concepts similar to those described in paragraph BC38(c) of Update 2016-08 on variable consideration similarly apply to lessors with variable payments for which there is uncertainty in the amounts of the variable payments and that uncertainty is not expected to ultimately be resolved. Specifically, the Board discussed that a reasoning similar to that described in paragraph BC38(c) of Update 2016-08 should be applied by lessors because leasing is fundamentally a revenue-generating activity for a lessor. In addition, the issue raised in Topic 606
on the requirement to recognize variable consideration for which the uncertainty will ultimately not be resolved also exists in Topic 842
BC20. The amendments in the proposed Update were not specific about the type of Lessee-Paid costs to which the proposed amendments would apply because it was expected that facts and circumstances would dictate whether there was uncertainty about the amounts and whether that uncertainty was expected to ultimately be resolved. However, at its July 25, 2018 meeting, the Board decided that when a contract is or contains a lease, the uncertainty in the amount of the variable payments would not be expected to ultimately be resolved when the lessor costs paid by the lessee are not readily determinable by the lessor. Therefore, the Board proposed a clarification in paragraph 842-10-15-40A that a lessor would exclude from variable payments lessor costs paid by a lessee directly to a third party when the amount of the lessor costs paid by the lessee is not readily determinable by the lessor.
BC21. The Board proposed using the term readily determinable
because guidance in Topic 842
already exists using that term (paragraph 842-20-30-3 requires a lessee to use the rate implicit in the lease whenever that rate is readily determinable) and using that term for Lessee-Paid costs would appear to address the operability challenges raised by lessor stakeholders. The Board concluded that the amount of lessor costs paid by a lessee directly to third parties generally would not be readily determinable by a lessor when those costs are affected by lessee-specific factors (such as insurance costs paid by a lessee directly to an insurance provider when those costs are affected by the policy deductible or when the underlying asset is insured under a broader umbrella policy). The Board expected that a lessor would apply reasonable judgment in determining whether the proposed amendments could be applied to its facts and circumstances.
BC22. Because the Board’s intent was to align the basis for the amendments in the proposed Update with the discussion in paragraph BC38(c) of Update 2016-08, the Board did not extend the proposed amendments to Lessee-Reimbursed costs. The Board concluded that the reasoning in paragraph BC38(c) cannot be applied to Lessee-Reimbursed costs because there is no uncertainty about the amount of those costs. Therefore, those amounts were considered readily determinable and, thus, the reimbursements were to be recognized as variable lease payments in accordance with Topic 842
. The Board noted that although the economics of an arrangement with Lessee-Paid costs may be very similar to an arrangement with similar terms as Lessee-Reimbursed costs, the main difference between the two arrangements is that the lessor knows the amount of its costs that is reimbursed by the lessee and, thus, the amount of those costs would be readily determinable. Because Topic 842
requires that lessor costs be included as variable lease revenue, the Board concluded that when no uncertainty in those amounts exists, Lessee-Reimbursed costs are lessor costs for which the guidance in Topic 842
should be applied. Extending the request to transactions involving Lessee-Reimbursed costs would have been a significant change in the leases guidance and would not have been supported by the same basis for the Lessee-Paid costs.
BC23. Most respondents to the proposed Update supported the direction of the amendments for Lessee-Paid costs and expressed that the amendments would typically result in Lessee-Paid insurance costs not being accounted for as variable lease payments. The respondents expressed that this was an appropriate conclusion. However, a significant number of lessor respondents were concerned that Lessee-Paid property taxes would be considered readily determinable and, thus, would be required to be estimated and reported as variable lease payments. They asserted that property taxes paid directly by lessees pose challenges for lessors similar to those challenges supporting the accounting policy election for sales taxes and other similar taxes. Specifically, leased assets are located in numerous jurisdictions, and the laws in some jurisdictions may be unclear about which party to the transaction is primarily obligated for payment of the property taxes. They also asserted that determining the amount paid directly by lessees for property taxes is further complicated by the variation of, and changes in, tax laws among jurisdictions and lessee-specific factors. For example, lessees can control the location of certain leased assets, and, therefore, the jurisdictions in which those property taxes are assessed may be unknown to the lessor.
BC24. Along with operability issues for determining Lessee-Paid costs, those respondents indicated that property taxes and insurance costs are typically insignificant to total lease revenue. They also expressed that reporting those costs will generally not have a meaningful effect on financial reporting because the effect on net income would be zero (assuming zero profit margin on those costs). Consequently, they asked that the Board’s final guidance not require lessors to estimate those costs. Some respondents suggested that this could be achieved by clarifying that Lessee-Paid property taxes and insurance are not readily determinable.
BC25. Several respondents requested that the Board ensure that both Lessee-Paid property taxes and Lessee-Reimbursed property taxes be excluded from variable payments by either (a) including property taxes in the accounting policy election for sales taxes and other similar taxes or (b) providing a separate accounting policy election. Reasons provided by respondents are consistent with those provided to the Board during its initial deliberations (see paragraph BC18).
BC26. Several respondents, particularly practitioners, asserted that the application of readily determinable
was inoperable. Although respondents acknowledged that readily determinable
exists in other areas of GAAP and within Topic 842
, they expressed concern that the guidance would be applied inconsistently because of differing interpretations of readily determinable
. Others requested that the Board provide guidance on how much cost and effort are required for determining whether amounts are readily determinable.
BC27. At its October 31, 2018 meeting, the Board considered the feedback received on its proposed Update and deliberated alternatives to address the issues raised by respondents. The Board acknowledged the concerns about estimating costs paid directly by lessees to third parties, particularly the concerns about applying readily determinable. The Board also considered whether a separate accounting policy election should be provided for all variable property taxes (Lessee-Paid and Lessee-Reimbursed) whereby a lessor could elect to not account for those taxes as lessor costs.
BC28. The Board decided not to provide a separate accounting policy election for all property taxes, primarily because this election would have allowed a lessor to not account for Lessee-Reimbursed property taxes as variable payments (that is, they would not be accounted for as lessor costs). Although the economics between Lessee-Paid and Lessee-Reimbursed are similar in that both may be costs of the lessor, the Board highlighted that all Lessee-Reimbursed costs are known amounts to the lessor and concluded that those costs should be accounted for as lessor costs. This will result in all Lessee-Reimbursed costs (including property taxes) being reported as revenue with a related expense. The Board clarified in paragraph 842-10-15-40A that “costs excluded from the consideration in the contract that are paid by a lessor directly to a third party and are reimbursed by a lessee are considered lessor costs that shall be accounted for by the lessor as variable payments. . . .”
BC29. The Board acknowledged the concerns expressed by lessor respondents that estimating Lessee-Paid costs (particularly property taxes and insurance) would require significant effort to report information that may be unreliable. The Board also noted that reporting those costs as lease revenue with a corresponding expense would have zero effect on net income (assuming zero profit margin on those costs). Additionally, it is the Board’s understanding (a) that these amounts are typically insignificant to overall lease revenue and (b) that practice, in most instances, is currently excluding those amounts from lease revenue under Topic 840
. Therefore, the Board concluded that excluding all Lessee-Paid costs from being accounted for as variable payments should not be a significant change to current practice.
BC30. The Board agreed that although the term readily determinable
may be used in Topic 842
for determining the rate implicit in the lease and other areas of GAAP, it may be difficult to apply in the context of determining whether Lessee-Paid costs should be accounted for as variable payments. The Board wanted to eliminate the risk that the amendments in paragraph 842-10-15-40A would be interpreted and applied inconsistently. To alleviate those concerns, the Board decided to remove the term readily determinable
from the amendments in paragraph 842-10-15-40A. Consequently, lessors will be required, in accordance with paragraph 842-10-15-40A, to exclude from variable payments all Lessee-Paid costs. Thus, those costs will not be reported as lease revenue with a related expense. The Board concluded that this approach is justified on the basis of cost-benefit.