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ASU 2016-13, Financial Instruments – Credit Losses (Topic 326), the new current expected credit loss (CECL) impairment model, is applicable to net investments in leases associated with sales-type and direct financing leases. See LI 13 for information about the effective date of ASU 2016-13 and related releases.
The FASB recognized that these net investments include both financial elements (e.g., rental payments, residual value guarantee) and non-financial elements (e.g., unguaranteed residual), but concluded that applying a single impairment model to the recognized lease asset was preferable to assessing different elements of a single asset under different impairment models. Receivables arising from operating leases are not within the scope of CECL.
The CECL model requires recognition of an allowance for credit losses on the date that a sales-type or direct financing lease receivable is recognized, either through origination or acquisition. A variety of techniques may be used to estimate the allowance, but the lessor’s estimate of expected credit losses must include a measure of the expected risk of credit loss even if that risk is remote. The CECL model also requires the measurement of credit losses to be on a collective (pool) basis when individual assets share similar risk characteristics.
The initial measurement of the allowance for credit losses is as follows:
  • For leases that are originated, the initial measurement of the allowance for credit losses will be recorded through earnings. The allowance would be released with an offset to earnings if estimated collections improve.
  • For leases acquired either though a business combination or an asset purchase, we believe the lessor should assess whether the acquired leases would be considered purchased financial assets with credit deterioration (PCD) as defined in ASC 326. To the extent a lease is not considered PCD, the initial measurement of the allowance for credit losses would be reported in current earnings (similar to an originated lease). If a lease is considered PCD, the initial measurement of the allowance for credit losses will create a basis adjustment to the amortized cost basis of the net investment in the lease. This “gross up” will impact the calculation of lease income over the life of the lease. The allowance would be released with an offset to earnings if estimated collections improve, similar to the treatment for originated assets. See LI 9 for additional information on PCD assets.
The CECL model requires assessments of allowance amounts to determine whether they should be written off against the amortized cost basis of the receivables. Receivables (and allowance accounts) are written off either in full or in part when such amounts are deemed uncollectible. Each element of a lease receivable (financial or non-financial) could cause a write-off. Companies may need to establish policies and procedures to determine when receivables (and allowance balances) should be written off.
Sometimes a lessor may transfer the receivable associated with future rental payments but retain ownership of the underlying leased asset. The lessor should apply the guidance in ASC 860 to determine whether such transfer would be accounted for as a sale resulting in derecognition of the receivable. When the transfer of the receivable is accounted for as a sale, and the asset remaining relates to the unguaranteed residual value, the leasing guidance states that the lessor should begin applying ASC 360 to determine whether the unguaranteed residual asset is impaired, (i.e., the CECL model would no longer be applicable). We believe this guidance should not be extended to address situations when the lessor has not transferred receivables and the net investment of the lease consists of mainly the estimated residual value of the leased asset simply as a result of a lessee making payments. In these situations, we believe it is appropriate to continue applying the credit loss model in ASC 326 until the leased asset is obtained by the lessor at the end of the lease.
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