Accounting for Credit Impairment of Operating Lease Receivables

To Members of Nareit’s Accounting Committee and Regulatory Law Subcommittee:

On July 17, Nareit attended a meeting at which the Financial Accounting Standards Board (FASB) discussed whether it agreed with its staff’s response to a recent technical inquiry on the accounting for impairment of operating lease receivables.

The technical inquiry asked whether Subtopic 842-30, Leases - Lessor represents the complete set of guidance that should apply to the accounting for impairment of operating lease receivables; and, in addition to the requirements in Subtopic 842-30, if lessors can apply Topic 450, Contingencies, to recognize a general allowance on a portfolio of operating lease receivables.

The FASB staff’s view was yes - lessors have the option to recognize a general reserve for uncollectible operating lease receivables under the loss contingency guidance after applying the collectability guidance in Topic 842, Leases. The FASB concurred with the staff’s view.

This Alert is provided to ensure that Nareit members are aware of the various items that should be considered as a company develops its accounting policy for the impairment of operating lease receivables.

These items include:

  • The Leases Standard - Topic 842
  • July 17 FASB Meeting Handout - Lease Implementation - Impairment of Operating Lease Receivables
  • Comments made by FASB members at the July 17 FASB meeting

The Leases Standard - Topic 842

Topic 842, paragraphs 842-30-25-12 through 25-13 introduce a “collectibility constraint,” in recognizing operating lease revenue.

Paragraph 842-30-25-12 states:

If collectibility of the lease payments plus any amount necessary to satisfy a residual value guarantee (provided by the lessee or any other unrelated third party) is not probable at the commencement date, lease income shall be limited to the lesser of the income that would be recognized in accordance with paragraph 842-30-25-11(a) through (b) or the lease payments, including variable lease payments, that have been collected from the lessee.

Paragraph 842-30-25-13 states:

If the assessment of collectibility changes after the commencement date, any difference between the lease income that would have been recognized in accordance with paragraphs 842-30-25-11(a) through (b) and the lease payments, including variable lease payments, that have been collected from the lessee shall be recognized as a current-period adjustment to lease income.

Paragraphs 842-30-25-11(a) through (b) provide standards for recognizing income from leases.

The guidance in Topic 842-30 does not specifically address establishing general reserves for a pool of operating lease receivables. Prior to the new leases guidance, the FASB staff understood that lessors applied the guidance in Topic 310, Receivables, to account for the impairment of operating lease receivables. Topic 310 specifically refers to Topic 450, which provides general guidance on loss contingencies and requires that an entity accrue an estimated loss from loss contingencies by a charge to income if certain conditions are met.

July 17 Board Meeting Handout - Lease Implementation - Impairment of Operating Lease Receivables - Available here, please review PDF pages 11-15.

The FASB staff confirmed, in paragraph 14 on page 14/16 of the handout that “while it was not the Board’s intent to significantly change existing practice for accounting for impairment of operating lease receivables, the collectability constraint established in paragraphs 842-30-25-12 through 25-13 could be construed as a significant change to existing practice (emphasis added). To address those stakeholders’ concerns, the staff provided two broad methods to account for the impairment of operating lease receivables with the goal of minimizing potential disruption to current practice for this accounting.”

Method 1:

Under this method, a lessor would apply a strict interpretation of Topic 842-30-25-12 through 25-13 and account for the impairment of operating leases solely at the individual lease level. Under this method, no general allowance would be recognized on a portfolio of operating lease receivables.

Method 2:

Method 2 introduces the use of a general reserve “for a portfolio of operating leases that are individually considered collectible but for which the lessor estimates that a portion ultimately will be uncollectible…”

Comments made by FASB members at the July 17 meeting

The complete webcast is available here.

We strongly recommend that you listen to the entire three-minute section of this webcast during which Vice-Chair Jim Kroeker provides the FASB’s view of this matter.

The FASB indicated that it would monitor practice in this area and if there is significant, meaningful differences in practice, the FASB would consider whether standard setting is warranted.


Contact

George Yungmann (gyungmann@nareit.com) or Christopher Drula (cdrula@nareit.com).