Key Changes for Lessors Under FASB ASC Topic 842

In June 2020, the FASB issued ASU 2020-05 and delayed, for a second time, ASU 2016-02, Leases Topic 842 for non-public entities to be effective for annual periods beginning after December 15, 2021 and for public not-for-profit entities to be effective for annual periods beginning after December 15, 2019. Since its initial release, discussions around Topic 842 have typically focused on how lease accounting changes will affect lessees, but what about the parties on the other side of the contract? Although lessor accounting has not been fundamentally changed, the impact felt by lessees inevitably trickles over to those who own the leased assets. In addition, with the release and adoption of new revenue recognition standards under Topic 606, criteria have been updated to better align key aspects of lessor accounting with the new standard.

The following key changes to lessors have been implemented under Topic 842

• Definition of a lease – to align with Topic 606, a contract will qualify as a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. 
• Consideration allocation - Lessors are required to separate lease components from non-lease components and allocate consideration in the contract similar to transaction price allocations under Topic 606. Lessors may elect as a practical expedient, by a class of underlying asset, to not separate lease and non-lease components and instead account for them as a single combined component. To qualify for this election, the timing and pattern of transfer of the lease and non-lease components to the lessee must be the same, and if the lease component had been accounted for separately, it is classified as an operating lease. If the non-lease components are the predominant component under the practical expedient, the lessor should account for them under Topic 606.
• Leveraged leases – The concept of a leveraged lease is not recognized under the new guidance. Any leveraged leases in effect at the effective date of Topic 842 are allowed to be accounted for under current guidance until expiration.
• Sale leaseback transactions – The treatment of sale leaseback transactions is required to follow Topic 606 to determine whether or not control has transferred to the buyer-lessor. If the transfer of the asset meets Topic 606 requirements for the transfer of control and it is determined that a sale has occurred, the lessor will recognize a sale leaseback transaction under the new lease guidance. If the transaction does not qualify as a sale under Topic 606, the lessor cannot account for a purchase and any consideration paid for the asset is accounted for as a financing transaction between the two parties.
• Real estate leases – The new guidance does not differentiate between leases of real estate and leases of other assets.

Topic 842 does not substantially change lessor accounting models. The criteria and classification of leases remain similar to current guidance with leases classified into the following types: operating, sales-type, or direct financing leases. Overall balance sheet and income statement treatment remain relatively unmodified.

How could this impact lessors from an operational standpoint? Lessees are now required to report both an asset and liability for any operating leases that are longer than a 12-month term. Bringing these transactions onto the balance sheet will impact lessees in a number of ways, not limited to increases and impacts in balance sheet leverage and ratios which may affect debt covenant calculations.  This may shift lessees to request shorter-term leases or drive an overall increase in lessee negotiation or scrutinization of lease terms, as the impact of these transactions now impacts their balances sheets. These changes can ultimately affect the lease income recognized by those who own the assets.

Organizations need to find a suitable solution for calculating the FASB ASC Topic 842 right-of-use assets and lease liabilities at the transition date and the subsequent lease accounting.  Generally, an Excel-based solution would be appropriate for a noncomplex portfolio of 10 or fewer leases.  If the lease profile is more complex or greater than 10 individual leases, management is better served by a lease software solution, such as simpLEASE. In addition to offering our clients simpLEASE, Schneider Downs provides advisory services for the technical aspects of lease accounting. For more information concerning lease accounting and the impact on your organization, please visit the Schneider Downs Our Thoughts On blog or email us at [email protected].