The FASB has issued ASU 2021-05, Lessors – Certain Leases with Variable Lease Payments. This ASU is in response to implementation concerns brought to the attention of the FASB as public companies began implementing Topic 842.

The ASU amends the lease classification criteria for lessors in regards to contracts that have variable lease payments that do not depend on a reference index or a rate. As previously issued, ASC 842 required that a lessor determine if a lease is classified as a sales-type or direct-financing lease exclusive of variable payments that do not depend on a reference index or rate from the lease receivable. These variable payments were to be subsequently recognized as lease income when the changes in facts and circumstances occur that the variable payments are based upon. This situation could result in a lessor recognizing a loss at lease commencement (a “day-one loss”) despite the fact that the lessor expects the arrangement to be profitable overall.

The amendments in ASU 2021-05 change the lease classification requirements for lessors by adding an additional provision to the lease classification criteria to prevent a possible day-one loss. The additional provision states that any contract with a lease with variable lease payments that does not depend on an index or a rate that would otherwise result in a day-one loss if recognized as either a direct financing lease or a sales-type lease should instead be classified as an operating lease.

The amendments in the ASU should be implemented concurrently with the rest of Topic 842, if not already adopted, which is effective for non-public entities for annual periods beginning after December 15, 2021. Entities that have already adopted Topic 842 before the issuance of ASU 2021-05 may either apply the ASU retrospectively to leases that commenced after the adoption of Topic 842 or may apply the updates prospectively to leases that commence after the entity first applies the amendments.

The full text of ASU 2021-05 is available here.

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