FASB Finalizes Lessor Option to Keep CAM and Rent Combined in Some Cases
On July 30, the Financial Accounting Standards Board (FASB) issued an Accounting Standards Update (the ASU) that makes targeted improvements to the new leases standard. Of particular interest to real estate companies operating as equity REITs are the options to not separately present common area maintenance (CAM) from lease revenue (provided certain criteria are met) and to initially apply the new leases standard at the adoption date without having to restate prior periods. Nareit had previously raised the CAM issue with the FASB, but the FASB did not address the issue until Nareit member companies began planning the leases implementation during 2017.
Separating Components of a Contract
In accordance with the new leases standard, a company must separate lease components from non-lease components (e.g., CAM). The lease components are accounted for in accordance with the new leases standard, while the non-lease components are accounted for in accordance with other standards (e.g., Topic 606, Revenue from Contracts with Customers, for lessors). The consideration in the contract is allocated to the lease and non-lease components on a relative standalone price basis (for lessees) or in accordance with the allocation guidance in the new revenue standard (for lessors). The new leases standard also allows lessees, by class of underlying assets, to elect not to separate non-lease components from the associated lease component. If a lessee so elects, it is required to account for the non-lease components together with the associated lease component as a single lease component and to provide certain disclosures. However, the new leases standard did not provide lessors with a similar election.
The ASU addresses Nareit’s concerns about the requirement for lessors to separate components of a contract by providing lessors with an election, by class of underlying asset, to not separate non-lease components from the associated lease component, similar to the election provided for lessees. However, the lessor election is limited to circumstances in which the non-lease component(s) otherwise would be accounted for under the new revenue standard and both: 1) the timing and pattern of transfer are the same for the non-lease component(s) and associated lease component; and, 2) the lease component, if accounted for separately, would be classified as an operating lease.
The ASU clarifies which Topic (Topic 842, Leases, or Topic 606, Revenue from Contracts with Customers) applies for the combined component. Specifically, if the non-lease component(s) associated with the lease component are the predominant component of the combined component, a company should account for the combined component in accordance with Topic 606. Otherwise, the company should account for the combined component as an operating lease in accordance with Topic 842. A company that makes this election also must provide certain disclosures.
Given implementation concerns raised by constituents, the FASB approved an optional transition method in addition to the existing requirements for transition to the new Leases standard by recognizing a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. Consequently, a company’s reporting for the comparative periods presented in the financial statements would continue to be in accordance with current GAAP (Topic 840), including disclosures.
Lessor Disclosure Requirements
Lessors that make this election will be required to disclose the following, by class of underlying asset:
- Its accounting policy election and the class or classes of underlying assets to which it applies
- The nature of:
- The lease components and non-lease components combined as a result of making the election.
- The non-lease components, if any, that are accounted for separately from the combined component because they do not qualify for the election.
- The Topic the company applies to the combined component (i.e., Topic 842 or Topic 606).
Transition - Comparative Reporting at Adoption
Prior to this ASU, companies were required to adopt the new leases standard using a modified retrospective transition method. Under that method, a company would initially apply the new leases standard at the beginning of the earliest period presented in the financial statements. This would mean that the new leases standard would apply for Jan. 1, 2017 for calendar-year public companies that adopt the new leases standard on Jan. 1, 2019.
Given concerns raised by constituents, the FASB decided to provide another transition method by allowing companies to initially apply the new leases standard at the adoption date (e.g., Jan. 1, 2019 for calendar-year public companies). Companies would also recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption.
Transition and Effective Date
The amendments in the ASU related to separating components of a contract affect the guidance in the new leases standard, which is not yet effective but can be early adopted.
For companies that have not adopted Topic 842 before the issuance of the ASU, the effective date and transition requirements for the amendments in this ASU related to separating components of a contract are the same as the effective date and transition requirements of the new leases standard. For calendar year companies, the new leases standard is effective on Jan. 1, 2019.
For companies that have adopted Topic 842 before the issuance of the ASU, the transition and effective date of the amendments related to separating components of a contract are as follows:
- The election may be made either in the first reporting period following the issuance of this ASU or at the original effective date of Topic 842 for that company.
- The election may be applied either retrospectively or prospectively.
All companies, including companies that have early adopted the new leases standard, that make the election related to separating components of a contract in this ASU must apply the election, by class of underlying asset, to all existing lease transactions that so qualify at the date elected.