The Financial Accounting Standards Board issued an accounting standards update intended to improve an area of the leases guidance related to a lessor’s accounting for certain leases with variable lease payments.

During the FASB’s post-implementation review (PIR) of leases (Topic 842), the board received an agenda request highlighting an issue encountered by lessors. Specifically, a lessor may be required under Topic 842 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 will be profitable overall. Stakeholders highlighted that this accounting outcome results in financial reporting that does not faithfully represent the underlying economics either at lease commencement or over the lease term. Therefore, users of financial statements are not being provided with decision-useful information for those transactions.

To address this, the board issued an ASU to amend lessor lease classification requirements. Specifically, 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 resulting financial reporting 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.