FASB Approves Option to not Separate Common Area Maintenance from Lease Revenue
On March 28, the Financial Accounting Standards Board (FASB or board) held a meeting to discuss feedback that it received on its 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 decisions that further clarified the practical expedient to provide an option 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 coalitions of the residential and office REIT sectors submitted comment letters that argued that the allocation process would not provide meaningful information to users of financial statements.
Separating Components of a Contract
The proposal provided 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.
At the meeting, the FASB addressed constituents’ concerns about the first criterion that must be met to apply the practical expedient. Consistent with Nareit’s recommendation, the board amended the first criterion to be the following: “the timing and pattern of transfer are the same for the non-lease component and the related lease component.” Given the variability in the timing of some common area maintenance during the year ( e.g., snow removal in the winter months and landscaping in summer months), some constituents believed that the criterion in the proposal was too restrictive. Nareit was among those that alerted the FASB that the criterion, as originally written, would not achieve its intention of providing implementation relief.
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 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.
Accounting for Property Taxes and Insurance
Some constituents also asked the board to provide two additional practical expedients for lessors to not recognize lease revenue for certain property taxes and insurance costs that are paid directly by the lessee or paid by the lessor but reimbursed by the lessee. While the FASB appeared to be sympathetic to the complexities associated with this fact pattern, it was not clear how it planned to address the issue. The board is still considering whether this will be addressed as part of a technical corrections project or as part of a separate exposure draft. The FASB did not want to address this issue as part of the other decisions that were finalized during the meeting.