The FASB granted businesses and other organizations two significant breaks as they implement its lease standard. Companies will be able to avoid recasting prior year results using the new accounting when they adopt the standard. Instead, they can choose to recognize the cumulative effect of applying the new standard to leased assets and liabilities as an adjustment to the opening balance of retained earnings.
With less than six months before the deadline for public companies to comply with the FASB’s sweeping new lease accounting standard, the accounting board on July 30, 2018, gave businesses two significant breaks.
Accounting Standards Update (ASU) No. 2018-11, Leases (Topic 842): Targeted Improvements, relieves businesses and organizations from having to present prior comparative years’ results when they adopt the new standard. It also lets landlords and other lessors avoid breaking out the parts of a rental contract that are not specifically being leased, such as the cost of snow removal services, and account for them separately from the base rent.
Both aspects of the accounting standard, published in February 2016 as ASU No. 2016-02, Leases (Topic 842), caused more headaches than accountants expected once they started digging into the details of the new guidance, which becomes effective for public companies in 2019 and for private companies in 2020. In the more than two years since the FASB published the lease standard, the board has heard a consistent message from businesses and auditors: the standard, while not as technically complex as other accounting standards, requires businesses to collect reams of new data about rented items ranging from photocopiers to fleets of trucks that they did not have to track before.
According to ASU No. 2018-11, companies will be able to avoid recasting prior year results using the new accounting when they adopt the standard. Instead, they can choose to recognize the cumulative effect of applying the new standard to leased assets and liabilities as an adjustment to the opening balance of retained earnings. Essentially, it means less work for companies adopting the massive accounting change.
“When I talk with my clients these days about lease accounting, that’s one of the first things they ask me about — ‘when are they going to finalize this?'” said Grant Thornton LLP partner Daryl Buck, a member of the FASB from 2011 to 2016. “People have been anticipating its finalization greatly.”
The second part of the update affects fewer businesses, but for those affected by it, the relief is welcome.
Under the FASB’s original lease accounting standard, landlords and other lessors had to break down rent payments into lease and nonlease components and account for them separately. This meant that for a tenant renting the floor of an office tower, the landlord would have to pull out services such as snow removal or fixing toilets, put a price on them, and account for them separately from the base real estate rent. The FASB wanted lessors to account for the base rent as a lease but the money earmarked for so-called “common area maintenance” under other areas of U.S. GAAP, such as revenue accounting.
Several real estate investment trusts (REITs) told the FASB that the standalone price for services, such as security or elevator maintenance for one tenant in a multi-unit building would be hard to quantify, and it would not change the pattern and timing for recognizing total operating revenues.
George Yungmann, senior vice president, financial standards, at the National Association of Real Estate Investment Trusts (NAREIT), described the exercise as “mathematical gymnastics” that did not reflect the economics of a rental arrangement. In addition, real estate companies had a hard time tracking down market-rate prices of typically bundled services such as parking lot repair or landscaping.
“We were getting emails every other day, ‘You don’t understand; we can’t implement this, even if we wanted to because there’s no standalone selling price. There’s no legitimate way of allocating the revenue between the components’,” Yungmann said.
Under the FASB’s update, the lessor would have the option to not separately account for the nonlease components if it meets certain conditions.
“What the FASB said is, ‘if you don’t want to split it up, OK, you don’t have to’,” said Bruce Pounder, founder and executive director of GAAP Lab LLC, an accounting advisory services firm. “Essentially what it says is, ‘OK, you can choose to split these sorts of hybrid arrangements into their components’.”
The final update is based on a proposal the FASB floated in January via Proposed ASU No. 2018-200, Leases (Topic 842): Targeted Improvements.
For in-depth analysis of the FASB’s standard for lease accounting, please see Catalyst: US GAAP — Leases , also on Checkpoint.