To appropriately implement Accounting Standards Update No. 2016-02, Leases and Subsequent Updates (Topic 842), it is crucial to identify any scope exceptions to the new lease accounting standard. The scope of Topic 842 is substantially the same as lease accounting under legacy US GAAP, Topic 840.
Topic 842 applies to leases, including subleases, that meet the definition under Topic 842 as described in Implementing the New FASB Lease Accounting Standard: Identifying the Lease. In addition to leases of tangible assets and sales leaseback transactions, Topic 842 applies to long term leases of land, leases of non-core assets (e.g. administrative offices), and certain sales with repurchase rights from the supplier’s perspective (e.g. call or put options).
Topic 842 does not apply to the following areas:
Leases of Inventory:
Leases of inventory are in scope of Topic 330 (Inventory). The determination of an asset as inventory should be made from the customer’s perspective; an asset should not be scoped out of Topic 842 because the supplier classifies the asset as inventory. For example, a supplier may classify a fleet of vehicles to be leased or sold to customers as inventory; however, if a customer were to lease a vehicle from the supplier, the right to use the asset may fall under Topic 842.
Leases of Intangible Assets:
Intangible assets, such as goodwill and the rights to use intangible assets, are accounted for under Topic 350 (Intangibles – Goodwill and Other).
Leases of Assets Under Construction:
Lease of assets under construction fall under Topic 360 (Property, Plant, and Equipment) unless the lessee controls the asset under construction before the lease commencement date. If the lessee controls the asset under construction before the lease commencement date, the transaction falls under Topic 842 sales leaseback guidance. Topic 842 also includes guidance on accounting for construction and design costs related to the underlying asset in a lease.
Leases of Biological Assets, Including Timber:
Leases of biological assets, such as crops, are accounted for under Topic 905 (Agriculture).
Leases to Explore for or Use Non-regenerative Resources:
Leases to explore for, or use, natural resources, such as minerals, oils, or natural gases, are accounted for under Topic 930 and 932. This includes right to use the land containing the non-regenerative resources, unless the rights of use contain more than the right to explore for non-regenerative resources. Additionally, rights to use equipment used to explore for non-regenerative resources fall under Topic 842.
A derivative instrument is a financial instrument whose value is dependent on a variable, such as interest rate or commodity price. Derivative instruments are typically accounted for under Topic 815 (Derivative and Hedging). Leases under Topic 842 are not considered to be derivative instruments under Topic 815, however a derivative instrument embedded in a lease may be in scope of Topic 815.
One type of derivative instrument that may be embedded in a lease is a residual value guarantee. If the residual value guarantee falls under Topic 842, it is not within the scope of Topic 815.
Service Concession Arrangements
A service concession arrangement is an arrangement between a government or public sector entity and a private operating entity for the private operating entity to develop, operate, and/or maintain an infrastructure asset, such as roads, sewers, hospitals etc. Service concession arrangements are accounted for under Topic 853 (Service Concession Arrangements). Amendments to Topic 853 state that the right to use an infrastructure asset in a service concession arrangement is not within scope of Topic 842.
Accounting Policy Elections
Further scope exceptions to Topic 842 may arise from accounting policy elections, including the option to exclude short term leases and establishing a lease capitalization policy.
An entity may elect to exclude short term leases from treatment under Topic 842 if the lease term is 12 months or less and does not include an option to purchase the asset or extend the lease that the entity is reasonably certain to exercise. If this accounting policy election is made, the short-term leases are accounted for as executory contracts with similar accounting treatment as operating leases under legacy US GAAP, Topic 840.
Additionally, an entity may set a minimum recognition threshold to apply Topic 842 to its leases to scope out leases deemed immaterial based on the net present value of future lease payments. Like the treatment of short-term leases, leases that are under the recognition threshold receive similar accounting treatment as operating leases under legacy US GAAP, Topic 840.
See further discussion of both accounting policy elections in Implementing the New FASB Lease Accounting Standard: Identifying the Lease.
If you have questions regarding the new lease standard, or you need assistance implementing it for your organization, please send us an email.
Author Kate Kohlwes is a manager in Clark Nuber’s Audit and Assurance Services Group.
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