Alert: FASB Accounting Standards Update No. 2018-10 – Codification Improvements to Leases

Category: US GAAP

Alert: FASB Accounting Standards Update No. 2018-10 – Codification Improvements to Leases

On July 19, 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-10 Codification Improvements to Topic 842, Leases. This ASU addresses narrow aspects of the guidance requiring further clarification and corrects for unintended application of the guidance as identified through inquiries and feedback received from stakeholders.

The amendments in the ASU include the following clarifications:

  • Correction of a cross-reference in paragraph 460-10-60-32 of Guarantees (Topic 460) and implementation guidance in Topic 842 about residual value guarantees by a seller-lessee in a sale and leaseback transaction.
  • If the rate determined when applying the definition of the term rate implicit in the lease results in a negative rate, a rate implicit in the lease of zero is used. In addition, the illustration on how initial direct costs factor into determining the rate implicit in the lease have been aligned with the applicable guidance.
  • When reassessment of lease classification is required, including when there is a change in the lease term or in the assessment of the lessee’s likelihood of exercising an option to purchase the underlying asset, the lessee or lessor reassesses the classification of the lease on the basis of facts and circumstances (and modified terms and conditions, if applicable) as of the date the reassessment is required.
  • A lessor accounts for the exercise of a lessee’s option to purchase the underlying asset or option to extend or terminate the lease in the same manner as a lease modification, unless the exercise of that option by the lessee is consistent with the assumptions the lessor made in accounting for the lease at the commencement date of the lease or the most recent effective date of a modification not separately accounted for.
  • A change in a reference index or rate upon which some or all of the variable lease payments in a contract are based does not constitute the resolution of a contingency requiring a remeasurement of the lease payments.
  • Removal of an inconsistency in terminology used about the effect that investment tax credits have on the fair value of the underlying asset between the definition of the term rate implicit in the lease and the lease classification guidance.
  • The period covered by a lessor-controlled option to terminate the lease is included in the determination of the lease term.
  • The application of the impairment guidance to lessors for net investment in a lease is clarified and includes updated guidance as to which cash flows to consider in that impairment assessment.
  • A lessor should not continue to accrete the unguaranteed residual asset to its estimated value over the remaining lease term to the extent that the lessor sells substantially all of the lease receivable associated with a direct financing lease or a sales-type lease, consistent with Leases (Topic 840).
  • A seller-lessee in a failed sale and leaseback transaction adjusts the interest rate on its financial liability to ensure that the interest on the financial liability does not exceed the total payments (rather than the principal payments) on the financial liability.

The amendments also provide clarifications to transition guidance for:

  • Assets or liabilities recognized by lessors in accordance with Business Combinations (Topic 805) for favourable or unfavourable terms of an operating lease acquired as part of a business combination.
  • When to recognize certain transition adjustments to earnings rather than through equity when Topic 842 is initially applied retrospectively to each prior reporting period.
  • Modifications beginning on the effective date that are applicable to lessors for leases previously classified as direct financing or sales-type leases under Topic 840, and classified as direct financing leases or sales-type leases under Topic 842.
  • The application of sale and leaseback transactions occurring before the effective date.
  • A reference provided for the subsequent measurement of a lease previously classified as a capital lease under Topic 840, and classified as a finance lease under Topic 842.

For entities that early adopted Topic 842, the amendments are effective immediately, and the transition requirements are the same as those in Topic 842. For other entities, the effective date and transition requirements will be the same as the effective date and transition requirements in Topic 842.

To access the full script of ASU No. 2018-10, click here.

This communication contains a general overview of the topic and is current as of July 19, 2018. The application of the principles addressed will depend upon the particular facts and circumstances of each individual case. Accordingly, this publication is not a substitute for professional advice and we recommend that any decisions you take about the application or not of any of the information presented be made in consultation with a qualified professional, who can address any variance that may be required to reflect your circumstances. Please contact your local MNP representative for customized assistance with the application of this material. MNP LLP accepts no responsibility or liability for any loss related to any person's use of or reliance upon this material. © MNP LLP 2018. All rights reserved.

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Michelle Balmer

Michelle Balmer CPA, CA

Vice President, Assurance

Michelle Balmer, CPA, CA, is a Senior Assurance Services Partner with MNP. With 14 years of experience in public practice, Michelle helps a broad range of public and privately held companies in a variety of industries. She also works on special projects, including costing studies, benchmarking and best-practice studies, operational analyses, litigation support and due diligence.

As a key member of MNP's Assurance team, Michelle has played an instrumental role in assurance policy development, implementing accounting and assurance standards firm-wide and educating assurance practitioners regarding methodologies and new pronouncements. She also provides technical advice and consultation on accounting and assurance issues, as well as on rules of professional conduct issues, to all MNP practitioners.

Michelle was certified a Chartered Accountant (CA) after obtaining a Bachelor of Commerce degree from the University of Alberta. She has been actively involved with the Institute of Chartered Accountants of Alberta, including the Chartered Accountants School of Business, in an instructional and marketing capacity. An avid volunteer, she has assisted numerous groups such as the Easter Seals of Alberta, Paralympic Sports Association and Junior Achievement of Northern Alberta.