Updated on April 10, 2023: The first amendment in this update allows for private and certain not-for-profit entities to use the written terms of the related party arrangement to determine if a lease exists and if so, the classification and accounting for the lease. Prior to issuance of this ASU, organizations were seeking outside counsel to determine what is legally enforceable, which was costly. This practical expedient is expected to reduce costs and can be applied on an arrangement-by-arrangement basis. 

The second amendment requires that leasehold improvements for related party leases be amortized by the lessee over the useful life of the improvement as long as the lessee controls the use of the asset.  

Both amendments are effective for fiscal years beginning after 12/15/23 with early adoption permitted.

On July 30, 2018, the FASB issued a greatly anticipated Accounting Standards Update (ASU) related to the new lease accounting standard. This update, known as ASU 2018-11, Leases (Topic 842): Targeted Improvements, contains two provisions that intend to make the transition from ASC 840 to ASC 842 easier and less costly. One is an additional transition method, providing transition relief of great interest to lessees and lessors. The other provides a practical expedient for lessors in their identification and separation of lease components.

Additional Transition Method

ASU 2018-11 provides an optional method that greatly simplifies the transition to the new lease accounting standard. As it was originally written, the new lease accounting standard required adoption using a modified retrospective transition method as of the first date reflected on the financial statements. This additional transition method permits entities to use the effective date of the new lease accounting standard as the date of initial application. For example, most privately held companies whose fiscal year end coincides with the end of a calendar year could use January 1, 2021, as their initial application date.

With the additional transition method provided in ASU 2018-11, comparative prior-year financial statements do not have to be restated. Instead, they will continue to be presented under the current accounting guidelines for leases under ASC 840. A cumulative-effect adjustment is recognized to the opening balance of retained earnings in the period of adoption rather than in the earliest period presented in the financial statements.

In addition, lease disclosures under the new lease accounting standard and ASC 2018-11 are not required for periods before the effective date. The lease disclosures for prior years presented in comparative financial statements under ASC 840 are presented in accordance with ASC 840 and carried forward from prior year statements, rather than under ASC 842.

The following example illustrates the election of the transition option for a calendar year entity that adopts the standard on January 1, 2021, and presents comparative financial statements for 2020:

                                                                 Elects New Transition Option            Does Not Elect

Date to apply transition provisions   1/1/2021 (effective date)                      1/1/2020

Date to present right to use assets    1/1/2021                                                 1/1/2020
and related lease liabilities

Cumulative effect adjustment             1/1/2021                                                  1/1/2020
to Retained Earnings as of                                                              

Required to restate prior year             No                                                           Yes
comparative financial statements?                                                                

Presentation of leases in                      ASC 840                                                 ASC 842
comparative financial statements

Prior year lease disclosures                 ASC 840                                                 ASC 842

Current year lease disclosures            ASC 842                                                 ASC 842

While this additional transition method under ASU 2018-11 allows organizations to not restate prior periods, the modified transition approach must still be applied upon adoption. Even with that, this additional transition method significantly reduces the cost and complexity of implementing the new lease accounting standard for organizations with comparative prior periods in the year of adoption.

Separation of Components for Lessors

ASU 2018-11 also contains a practical expedient that allows lessors to elect not to separate lease components from nonlease components within a contract but instead to account for them as a single component. This practical expedient can only be elected if both of the following conditions are met:

1. The lease component, if accounted for separately, would be classified as an operating lease.

2. The timing and pattern of transfer/revenue recognition for the lease and nonlease components are the same.

The FASB made this change in ASU 2018-11 to address concerns raised by implementers. These concerns were related to the difficulty of determining standalone selling prices for lease and nonlease components that are not sold separately. Additionally, there were concerns about the relevance of information about separate components to financial statement users.

Prior guidance in the new lease accounting standard required that lessors always separate and allocate consideration in the contract to lease and nonlease components. Once separated, the nonlease components would be accounted for and disclosed in accordance with ASC 606: Revenue From Contracts With Customers, and the lease components would be accounted for and disclosed based on the new lease accounting standard. The practical expedient for lessees in ASC 842-10-15-37 to elect not to separate nonlease from lease components was not available to lessors.

Under ASU 2018-11, lessors will have to apply judgment to determine which of the components is predominant; that is, the component that is expected to have more value. When combined using the practical expedient, if the nonlease component is the predominant component, the accounting will follow ASC 606. If the nonlease component is not predominant, then the single component is accounted for as an operating lease under the new lease accounting standard.

The practical expedient must be applied consistently as an accounting policy by class of underlying asset. For nonlease components that do not qualify for the practical expedient, lessors will allocate consideration to those components on a relative standalone selling price basis and account for them based on ASC 606.

For lessors that elect this practical expedient, the following disclosures are required: that the expedient was elected; which asset classes the election applies to; the nature of the items that are being combined along with any nonlease components that were not eligible and were not combined; and the accounting guidance applied to the combined component (ASC 606 or 842). ASU 2018-11 has the same effective date as the new lease accounting standard.

ASU 2018-11 and LeaseCrunch

Although the new lease accounting standard has already gone into effect, CPA firms and their clients should discuss all elements of their leases because the decisions made will continue to impact the transition to ASC 842.

For additional information about how LeaseCrunch can support you as you help your clients transition in accordance with ASU 2018-11, contact us today or request a demo to learn more about what our automated lease accounting software can do for you.