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9.5 Lessor transition
Publication date: 31 Jan 2023
us Leases guide
The transition guidance for a lessor differs in some respects depending on the classification of the lease. Given that the practical expedients discussed in LG 9.3.1.1 allow reporting entities to avoid reconsidering lease classification, we expect that many lease arrangements will retain their original classification and therefore, the accounting for a change in classification is not discussed in this guide. Readers should refer to ASC 842-10-65-1 for guidance.
9.5.1 Lessor: operating leases in transition
If a lease was classified as an operating lease under the guidance in ASC 840 and will continue to be classified as an operating lease under the leases standard, the lessor should continue to recognize the carrying amount of the underlying asset and any lease assets or liabilities (for example, prepaid or deferred rent) at the same amounts previously recognized in accordance with ASC 840. However, refer to LG 9.3.1.2 when the hindsight practical expedient is elected.
If the entity elects the package of practical expedients discussed in LG 9.3.1.1, it does not reassess unamortized initial direct costs. If a reporting entity does not elect the package of practical expedients, unamortized initial direct costs that do not qualify for capitalization under the leases standard should be written off with an offsetting entry to opening equity unless the entity chooses to adjust comparative periods and the costs were incurred after the beginning of the earliest period presented. In this case, they should be written off to earnings in the comparative period. Unamortized initial direct costs that qualify for capitalization under the leases standard (see LG 4.3.1.2) should remain capitalized and continue to be expensed over the lease term.
9.5.2 Direct financing and sales-type leases in transition
If a lease was classified as a direct financing or sales-type lease in accordance with ASC 840 and will be classified similarly under the leases standard, the lessor should continue to recognize its net investment in the lease at the later of the earliest period presented or lease commencement. The net investment amount is the same as the carrying amount measured using the guidance in ASC 840 immediately before that date. However, see LG 9.3.1.2 and Question LG 9-7 when the hindsight practical expedient is elected.
For a direct financing lease, the net investment in the lease should include any unamortized initial direct costs capitalized in accordance with ASC 840. The transition guidance in the leases standard does not require lessors to write off initial direct costs that do not meet the definition of initial direct costs under the new guidance even if the entity does not elect the package of practical expedients.
For lessors that choose to adjust comparative periods presented before the effective date, a lessor should account for the lease in accordance with the subsequent measurement guidance in ASC 840 during the comparative periods. Beginning on the effective date, a lessor should account for the lease in accordance with the recognition and measurement guidance in the leases standard. See LG 4.5.1 for information.
9.5.3 Leveraged leases in transition
Leases that commenced before the effective date of the leases standard that were previously classified as leveraged leases, may continue to be accounted for as leveraged leases by the lessor. Lessors should apply the guidance in ASC 842-50, which is consistent with legacy leveraged lease accounting guidance. New leases (or leases not previously classified as leveraged leases) and leveraged leases modified on or after the effective date cannot be classified as leveraged leases but will need to be classified using the new standard. See LG 7 for more information regarding leveraged leases.
9.5.4 Separation and allocation of components
Under the leases guidance, a reporting entity is required to separate lease and nonlease components and allocate consideration in the contract to each component. However, a lessor may, as an accounting policy election by class of underlying asset, choose to not separate nonlease components from the associated lease components and instead account for each separate lease component and its associated nonlease components as a single lease component provided certain conditions are met. See LG 2.4 for more information.
Question LG 9-15 discusses contract consideration reallocation upon adoption of the revenue recognition standard.
Question LG 9-15
Is a reporting entity required to reallocate contract consideration between revenue components and lease components when adopting the revenue standard (ASC 606)?
Is a reporting entity required to reallocate contract consideration between revenue components and lease components when adopting the revenue standard (ASC 606)?
PwC response
This question arises in the context of a reporting entity adopting the new revenue recognition standard before the leases standard.
If a reporting entity adopts the new revenue standard and the leases standard at the same time and also elects the package of practical expedients in the leases standard, the entity is not required to reassess the accounting for lease components, including the allocations between lease and nonlease components in contracts restated under the new revenue standard.
However, the transition guidance in the new revenue standard does not explicitly provide any relief from the requirement to separate lease and nonlease components if a reporting entity adopts the new revenue standard before the leases standard.
The FASB explained in a Board meeting on June 21, 2017 that it did not intend for a reporting entity to revisit the allocation of contract consideration to lease components within the scope of the existing leases guidance when the entity adopts the new revenue standard.
9.5.4.1 Presentation of tenant reimbursements
Lessors of real estate frequently pass the costs of insurance, maintenance, and property taxes (collectively, executory costs) on to their lessees for reimbursement, and present the tenant reimbursements in a separate income statement line item under ASC 840. Executory costs as defined under ASC 840, however, are accounted for differently under ASC 842. Under ASC 842, property taxes and insurance are not separate components in an arrangement (i.e., they are neither lease components nor nonlease components; they are additional consideration in the contract), whereas maintenance is a nonlease component that should be accounted for under ASC 606. (See LG 2.4.1 for additional information on identifying lease and nonlease components.) These changes may lead to questions as to how lessors should present these recovered costs for existing leases upon adopting ASC 842.
We believe that upon adopting ASC 842, lessors that elect the package of practical expedients described in LG 9.3.1.1 may continue (prospectively) to present existing leases in a consistent manner with how they had done so previously. Because this differs from the accounting under ASC 842 that will apply to new or modified leases, lessors should disclose the difference in presentation of their existing leases. Alternately, we believe that it would be acceptable to conform the presentation of existing leases to the presentation of leases entered into or modified after the effective date of ASC 842.
As described in LG 2.4.4.1, lessors may also elect, by class of underlying assets, to combine lease and nonlease components. Per ASC 842-10-65-2, this election applies to “all new and existing leases.” Accordingly, a lessor that elects to not separate lease and nonlease components must also combine such components for existing leases (for the applicable class of underlying asset) upon adoption, and it would no longer be appropriate to present the nonlease maintenance component (or the reimbursable insurance and property taxes) in a separate tenant reimbursement income statement line item after the effective date of ASC 842.
As for the comparative periods prior to adopting ASC 842, we believe that lessors that have elected the transition method to not adjust prior periods should present their comparative periods as they had before adopting ASC 842. We believe that the Board’s intent in providing the optional transition method was to allow entities to continue to report leases for the comparative period as they had under ASC 840.
9.5.5 Lessor: modification during comparative periods
Generally, when there is no change in lease classification, a lessor that elects to adjust comparative periods will apply the modification guidance in ASC 840 for modifications that occur during the comparative periods presented. If the lease classification changes, the lessor should use the modification model in ASC 842 irrespective of whether the modification took place during the comparative periods or after the effective date.
Question LG 9-16 discusses how lessors should account for lease modifications during the look-back period.
Question LG 9-16
Assume a lessor elects the package of practical expedients upon adoption of the leases standard and chooses to adjust comparative periods. What is the accounting if an operating or sales-type or direct financing lease under ASC 840 is modified during the look-back period?
Assume a lessor elects the package of practical expedients upon adoption of the leases standard and chooses to adjust comparative periods. What is the accounting if an operating or sales-type or direct financing lease under ASC 840 is modified during the look-back period?
PwC response
The transition provisions in ASC 842 do not provide any guidance on the accounting in this scenario. We believe the lessor should follow the modification guidance in ASC 840 should there be a modification of the lease during the look-back period. Modification guidance under the leases standard should be followed for a modification after the look-back period.
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