FASB Proposes Option to not Separate Common Area Maintenance from Lease Revenue
On Jan. 5, the Financial Accounting Standards Board (FASB or board) issued a proposal (the proposal) that would make targeted improvements to the Leases standard. Real estate companies operating as equity REITs will be particularly interested in the FASB’s practical expedient to not separate components in a lease contract (e.g., common area maintenance) provided that certain conditions are met. Under Topic 842 Leases, companies are required to separate lease components from non-lease components in a contract. The lease components are accounted for in accordance with the new lease requirements, while the non-lease components are accounted for in accordance with other Topics (e.g., Topic 606, Revenue from Contracts with Customers). Nareit and its members have contended that the allocation process would not provide meaningful information to users of financial statements in previous comment letters and in meetings with members of the board. If you are interested in participating in a task force that will evaluate the proposal and consider whether Nareit should develop a comment letter, please contact Christopher Drula (firstname.lastname@example.org) by Jan. 17. Comment letters are due to the board by Feb. 5.
Separating Components of a Contract
The proposal would address constituents’ concerns about the requirement for lessors to separate components of a contract. The proposal provides lessors with a practical expedient by class of underlying assets to not separate non-lease components from the lease component. However, the practical expedient would be limited to circumstances in which (1) the timing and pattern of revenue recognition are the same for the non-lease component and the related lease component and (2) the combined single lease component would be classified as an operating lease.
Comparative Reporting at Adoption
The Leases standard requires companies to adopt the new lease requirements using a modified retrospective transition method whereby the company initially applies the new lease requirements at the beginning of the earliest period presented in the financial statements. Thus, lessees must recognize lease assets and lease liabilities on the balance sheet for all leases, and must provide new and enhanced disclosures for each period presented.
Given implementation concerns raised by constituents, the board decided to allow another 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.