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FASB Proposes Targeted Improvements to ASC 842

by Tom Brunton
November 02, 2020

Here's how the changes impact you, whether you've already adopted ASC 842 or not.

As a result of the post-implementation feedback received by the FASB, a new proposal was released that would provide three targeted improvements to the new Leasing Standard. These improvements would impact everyone, whether you already adopted ASC 842 or are still going through the process. The proposed updates would impact the guidance in the following respects:

Provide lessees with the ability to remeasure lease liabilities for changes in an index or rate.

This provides lessees with the option to remeasure variable lease payments based on an index or rate (e.g., the Consumer Price Index, aka CPI) when there is a change in the index or rate that will affect future lease payments. Under ASC 842, a lessee measures variable lease payments using the prevailing index or rate at the lease commencement date, and changes in variable lease payments result in a re-measurement of the lease liability only when the lease liability is remeasured for another reason (e.g., a change in the lease term).

Under the current guidance, any change in the index rate would simply run through the current period P&L. The FASB proposed giving lessees an option to remeasure lease liabilities for changes in a reference index or rate affecting future lease payments on the date that those changes take effect. If this option is selected, lessees would be required to apply it on an entity-wide basis.

An example of this would be when a lessee enters into a three-year lease agreement with fixed lease payments in year one and payments that are adjusted at the beginning of years two and three based on CPI changes would allow for its lease payments to be remeasured each year when the change in CPI takes effect.

This change would more closely align with IFRS 16 and U.S. GAAP as it relates to lease payments that vary based on an index or rate.

Exempt both lessees and lessors from applying the standard's modification guidance when one or more lease components are terminated before the end of the lease term, but the terms relating to the remaining lease components stay the same.

This would prevent an organization — either a lessee or lessor — from having to reassess the lease classification or remeasure the discount rate. Prime examples of these arrangements would include the early termination of vehicles under a fleet agreement or the modification to reduce the number of floors being leased.

Fear not! If you didn't separate the lease components at the start of the lease because it would have been inconsequential, you would still be able to take advantage of this improvement.

I've changed this since blogs should be somewhat personal even with technical topics. If the definition of "commencement of the lease" is strict, we can change it back.

Lessors would be forced to classify leases with predominantly variable lease payments and not based on an index or rate as operating leases.

The last targeted proposal only applies to lessors and requires that leases with lease payments that are predominantly variable and are not based on an index or rate (e.g., a long-term lease of machinery where the consideration in the contract is determined based on hours used by the lessee) be classified as operating leases.

How does this impact those who have already adopted ASC 842?

As of the effective date, an entity would be permitted to apply the amendments on lease modifications and lessor classification either retrospectively to their date of adoption of ASC 842 or on a prospective basis to new or modified leases. A note of caution — a lessee that elects to apply the option to remeasure variable payments (based on an index or rate) on a prospective basis would have to apply it to all leases that exist on or start after the date the entity first applies the amendments.

What about those who haven't yet transitioned to ASC 842?

If these targeted improvements become final guidance ahead of the effective date of your implementation, you'd simply incorporate them as part of your adoption and then follow the transition requirements under ASC 842.

Have questions about how to apply these changes to ASC 842 to your organization or about other general lease accounting issues? Feel free to reach out to our team at .

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Authors
Tom Brunton, CFO Advisory, Armanino
Managing Director
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