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FASB Issues Standard on Lease Classification in Event of Variable Payments

Chris Gaetano
Published Date:
Jul 20, 2021

The Financial Accounting Standards Board (FASB) has issued a new standard opening up improved options for lessors accounting for variable payments in sales-type lease arrangements.

Under current lease standards, a lessor will sometimes be required to recognize a selling loss at lease commencement (day-one loss) for a sales-type lease with variable payments, even if the lessor expects the arrangement to be profitable overall. This is due to a quirk in the standards that prohibits lessors from estimating most variable lease payments and requires that they exclude those without an already-existing estimate from the value of the lease. But since the payments are variable, once the facts and circumstances change, these variable payments are recognized entirely as lease income. As a result, the net investment for a sales-type lease or a direct-financing lease with variable payments may be less than the carrying amount of the underlying asset derecognized at lease commencement.

 As a result, the lessor recognizes a selling loss at lease commencement even if the lessor expects the arrangement to be profitable overall.

Stakeholders said that this results in reporting outcomes that do not faithfully represent the underlying economics either at lease commencement or over the lease term. Those stakeholders emphasized that users of financial statements are not provided with financial information that is relevant or decision useful in those cases. Rather, the reporting of a loss is counter to the economics of those arrangements, and, thus, the accounting previously required fails to represent the underlying economics neutrally and faithfully. 

As a result, under the new standard, a lessor is now required to classify and account for a lease with variable payments as an operating lease if (a) the lease would have been classified as a sales-type lease or a direct-financing lease and (b) the lessor would have otherwise recognized a day-one loss. A day-one loss or profit is not recognized under operating lease accounting. The FASB says that this is expected to more faithfully represent the economics underlying the lease and improve the decision usefulness of information provided to the users of financial statements.

The new standard is effective starting Dec. 15, 2021, for public entities, and Dec. 15, 2022 for all others.

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