FINANCIAL REPORTING INSIGHTS  |  August 02, 2021

The Financial Accounting Standards Board recently issued Accounting Standards Update (ASU) 2021-05, Leases (Topic 842): Lessors – Certain Leases with Variable Lease Payments. This ASU addresses situations in which a lessor had been required to recognize a selling loss at lease commencement (a day-one loss) for a sales-type or direct-financing lease with variable payments of a certain magnitude even if the lessor expected the arrangement to be profitable overall.

Per ASU 2021-05, a lessor should classify and account for a lease with variable lease payments that do not depend on a reference index or a rate as an operating lease if both (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, thus resulting in financial reporting that better represents the economics underlying the lease.

The ASU is effective for fiscal years beginning after December 15, 2021, for all entities, and interim periods within those fiscal years for public business entities and interim periods within fiscal years beginning after December 15, 2022, for all other entities. Earlier application is permitted.

An entity that has adopted Topic 842 as of July 19, 2021 has the option of applying ASU 2021-05 either (a) retrospectively to leases that commenced or were modified on or after the adoption of ASU 2016-02, Leases (Topic 842), or (b) prospectively to leases that commence or are modified on or after the date on which the entity first applies ASU 2021-05.

An entity that has not adopted Topic 842 as of July 19, 2021 should follow the transition requirements of Topic 842 for the amendments in ASU 2021-05. This transition is either (a) retrospectively to each prior period presented in the financial statements with the cumulative effect of transition recognized at the beginning of the earliest period presented or (b) retrospectively to the beginning of the period of adoption with a cumulative effect of transition recognized at the beginning of the period of adoption.