FASB Decides to Extend Narrow-Scope Relief to Lessors in Implementing Topic 842
On Oct. 31, 2018
, the Financial Accounting Standards Board (FASB) held a decision-making meeting on its earlier proposed accounting update to Topic 842, Narrow-Scope Improvements for Lessors
. Since the go-live date for public enterprises was Jan. 1, 2019, for calendar year reporters, the decisions reached when formally issued will provide just-in-time relief for many lessors in implementing the new Leases standard. As of this writing, the Board had fast-tracked the formalization process with the goal of issuing the update by mid-December. Tentatively, for those entities who have not adopted early, the effective date and transition requirements of this update would be the same as those invoked in changing over from existing GAAP (Topic 840). For the very small population of early adopters, optionality is provided.
The tentatively-decided relief consists of (1) an accounting policy election to exclude from revenue sales and other similar taxes collected from lessees and (2) a rules-based approach for lessor costs related to the underlying leased asset (e.g., insurance and property taxes). The permitted policy election would extend by alignment the relief given to vendors (Topic 606) to lessors. Under the rules-based approach, lessee directly paid costs will be defined as lessee costs, while lessee-reimbursed costs will be defined as lessor costs. As discussed below, this relief intends to make the reporting of lessee-paid costs related to the underlying leased asset more operational by eliminating both the “readily determinable” hurdle for lessee paid amounts and the jurisdiction-by-jurisdiction tax research hurdle otherwise required to determine the primary obligor (the income statement reporter) of taxes imposed on the underlying asset.
Sales and Other Similar Taxes Collected from Customers
In May 2016, the FASB issued an accounting standards update to Topic 606 permitting a vendor by an accounting policy election to exclude sales and other similar taxes collected from its customers from the transaction price. Without the benefit of this election, the vendor would be tasked with determining on a jurisdiction-by-jurisdiction basis the primary obligor of the tax. If tax research identifies the vendor as the primary obligor, it would report the collected amount as revenue and the remitted amount as an expense (gross reporting). Otherwise, the vendor would report the activity as a collection agent (net reporting). In recognizing that the task could be unduly complex and costly for many entities, disproportionate to any benefit to the users of financial statements, the FASB provided relief.
Aligning Topic 842 with Topic 606.
The FASB’s tentative decision would align the scope exception afforded to vendors to lessors for sales, use, value added, some excise taxes and other similar taxes collected from lessees. However, this pending alignment will explicitly exclude revenue-related taxes assessed on lessor’s total gross receipts or on the “lessor as owner” of the underlying asset.
For equipment leasing, the issue generally arises in true leases where the lessor collects and remits use tax on the rental stream. It also arises when a lessor collects and remits sales tax assessed on the proceeds from sale of the underlying asset to the lessee or another end user. Since these taxes arise from revenue generating activities, these taxes qualify for the exclusion.
FASB tentatively decides to reinstate the fair value exception and cash flow reporting for financial lessors
On Dec. 4, 2018, the FASB reached tentative decisions on the following financial lessor issues related to the implementation of the new accounting for leases (Topic 842):
• Issue 1:
The Board decided to reinstate the fair value exception provided under existing GAAP to a lessor that is not a manufacturer or a dealer (a qualifying financial lessor). Under this exception, a qualifying financial lessor generally would continue to use its acquisition cost (entry price) as the fair value of the underlying asset at lease commencement for purposes of lease classification and measurement. Similar to existing GAAP, the exception would not apply if there has been a significant lapse of time between the acquisition date of the underlying asset and lease commencement, in which case the exit price definition in Topic 820 would apply.
• Issue 2:
The Board decided a lessor within the scope of Topic 842, Financial Services—Depository and Lending
, generally a financial lessor, should continue to present all principal payments received from sales-type and direct financing leases within investing activities in its statement of cash flows instead of in operating activities.
The reinstatement of this approach to day 1 fair value removes the possibility a lessor under Topic 842 would recognize a loss at the start of a sales-type or direct finance leases. The loss might have resulted from the use of an exit value for fair value because of differences in entry and exit market prices and due the incurrece of acquisition costs, such as sales taxes and delivery charges. Under the general fair value measurement principles of Topic 820, which covers the fair value topic, transaction costs incurred in connection with the acquisition of an asset generally do not qualify as asset costs and should be immediately expensed. In these two tentative decisions, the Board recognized that sales-type and direct financing leases originated by financial lessors fund an in-place asset and constitute a form of financing similar to secured lending. The first decision also, implicitly, recognizes that the fair value of the asset and the fair value of the lease are interconnected at lease commencement.
The FASB is expected to issue a proposed accounting standards update formalizing the above decisions near the end of 2018. This update will provide for a comment letter period ending the later of 15 days after issuance or Jan. 15, 2019. It will propose an effective date for fiscal years beginning on or after Dec. 15, 2019 (e.g., Jan. 1, 2020 for an entity with a calendar year-end) with early adoption permitted concurrent with the adoption of Topic 842 or any intervening interim period thereafter with retrospective application.
Lessor Costs: Insurance, Property Taxes, etc.
In Topic 842 as originally issued, consistent with Topic 606, the FASB concluded lessee reimbursement or direct payment of a lessor’s costs do not qualify as consideration in the contract because such activity does not transfer a good or service to the lessee separate from the right to use the underlying asset. Although these costs are contractually imposed on the lessee in triple-net leases, they remain lessor costs because the lessor is either the primary beneficiary (e.g., insurance) or the owner of the underlying asset (e.g., primary obligor of property taxes). However, in the deliberations, the FASB’s user representatives came to support relief and to provide consensus when the proposed exclusion changed from a blanket to a rules-based exclusion.
In triple-net leases of equipment or buildings the lessee as the contracting party generally pays the insurer directly. For these leases, the rules-based exclusion provides effective relief. In contrast, leases in many multitenant buildings are structured as gross or modified-gross leases with insurance listed as an itemized amount in the contract. Since the lessor is the contracting party with the insurer and thus pays the premiums, the proposed exclusion will not apply. Further, the itemized payment qualifies as a fixed lease payment subject to capitalization.
Property taxes in general.
The FASB views property taxes as a “lessor as owner” expense, the underlying principle for gross reporting. The preparer push for an exclusion for property taxes arises from similar considerations for the sales and other similar taxes exclusion (i.e., multiple local tax jurisdictions with a wide varying basis on which party to assess) and from the open-ended effort required to obtain tax assessment information for lessee directly paid taxes under the originally proposed “readily determinable” standard.
Personal property taxes. Even when the lessor is not the assessed party, many equipment lessors prefer lessee-reimbursed administration to ensure the leased asset remains lien free. These lessors will now face a trade-off decision—whether to continue as the intermediary or, alternatively, to allow or require lessee direct payment, adding monitoring, default, and curing procedures, to secure the benefit of net reporting. However, given the assessed amount is generally 1–2% of depreciating values, lessors might decide to continue as intermediaries and yet remain net reporters on the basis of immateriality.
Real estate property taxes.
Where tenants pay the property taxes directly, notably in triple net leases, the proposed exclusion provides effective relief. Otherwise, gross reporting will apply. This proposed rule-based framework will only apply to lessors; it will not affect the reporting or capitalization requirements for lessees.
While the FASB deliberations on the Leases project have remained guided by principles throughout, the Board has resolved implementation issues by allowing or issuing rules in the interest of making the new standard operational in a scalable manner.
Update: On Dec. 10, 2018 the FASB issued an accounting standards update codifying the earlier meeting decisions discussed above.