File Reference No Re: Proposed Accounting Standards Update, Leases (Topic 842): Targeted Improvements

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1 Deloitte & Touche LLP 695 East Main Street Stamford, CT Tel: Fax: Ms. Susan M. Cosper Technical Director Financial Accounting Standards Board 401 Merritt 7 P.O. Box 5116 Norwalk, CT Re: Proposed Accounting Standards Update, Leases (Topic 842): Targeted Improvements Dear Ms. Cosper: Deloitte & Touche LLP is pleased to comment on the FASB s proposed Accounting Standards Update (ASU) Leases (Topic 842): Targeted Improvements. We support the Board s efforts to amend certain aspects of ASU , Leases (Topic 842) to reduce the costs and complexity of implementing the standard. We think that the proposed ASU would further the Board s efforts by providing (1) transition relief in the form of an additional (and optional) transition method that would eliminate the requirement to provide comparative reporting at adoption and (2) lessors with a practical expedient under which they could elect not to separate nonlease components from the related lease components (the lessor practical expedient ). We believe that the additional transition method will provide critical relief to preparers in various industries who would otherwise have faced significant challenges in achieving a timely adoption of ASU Although we support the idea of a lessor practical expedient, we are concerned that the proposal, as drafted, leaves many open questions and believe that the Board should ensure that the guidance is clear and can be consistently applied in practice. We believe that additional outreach with stakeholders may be necessary in this regard. Appendix A contains our responses to the proposed ASU s questions for respondents. Appendix B explains in more detail our response to Question 4 regarding the lessor practical expedient and includes suggestions that we think would help preparers apply this expedient. *****

2 We appreciate the opportunity to comment on the proposed ASU. If you have any questions concerning our comments, please contact James Barker at (203) Yours truly, Deloitte & Touche LLP cc: Stephen McKinney Robert Uhl

3 Page 3 Appendix A Deloitte & Touche LLP Responses to Proposed ASU s Questions for Respondents Transition Comparative Reporting at Adoption Question 1: Would the proposed optional transition method to apply the new lease requirements through a cumulative-effect adjustment in the period of adoption reduce the costs and complexity associated with implementing Topic 842? If not, please explain why. We support the Board s proposal to amend certain aspects of ASU to allow for an optional transition method so that entities may elect not to restate their comparative periods in transition. This optional transition method will help relieve the additional and unexpected costs related to the current transition requirements in ASU that preparers have been experiencing. Those stakeholders indicated that they currently lack the IT solutions to handle the comparative-period reporting requirements of the current modified retrospective transition approach, thereby increasing the costs and complexity for those stakeholders. The Board s approach to the optional transition method will allow those stakeholders to adopt the new lease requirements in a cost-effective manner with fewer changes to systems. We agree with those Board members who noted, at the November 29, 2017, Board meeting, that when this transition method is allowed, the benefits to preparers of delaying balance sheet recognition by one year exceed the costs to financial statement users of not having comparative balance sheet information. Further, given ASC 842 s dual approach to lessee accounting, the new standard does not significantly affect the income statement. Therefore, comparability will not be significantly affected if entities do not apply the current modified retrospective transition approach. Question 2: Is the proposed transition method, as written in this proposed Update, operable? If not, please explain why. We think that the proposed ASU s transition method is operable as written. Separating Components of a Contract Question 3: Would the practical expedient in this proposed Update for lessors to not separate nonlease components from the related lease components and, instead, to account for those components as a single lease component reduce the costs and complexity associated with applying Topic 842 by lessors? If not, please explain why. We support the Board s proposal to amend ASC 842 to provide lessors with an optional practical expedient under which they will not have to separate nonlease components from lease components. An entity that elects the lessor practical expedient will be able to account for the lease component and the nonlease component(s) in an arrangement as a single lease component, if both (1) the timing and pattern of revenue recognition are the same for the nonlease component(s) and related lease component and (2) the combined single lease component would be classified as an operating lease.

4 Page 4 The Board s proposal will result in a reduction in the cost and complexity of applying ASC 842. However, we are concerned that challenges with applying the expedient will arise if additional implementation guidance is not provided. Therefore, before the Board finalizes the proposed lessor practical expedient, it may need to (1) conduct additional outreach with affected stakeholders and (2) modify various aspects of the related guidance to clarify the Board s intent. (Please see our response to Question 4 below for further discussion.) Question 4: Is the proposed practical expedient, as written in this proposed Update, operable? If not, please explain why. We think that there are challenges related to applying the guidance in ASC A, as proposed, that should be addressed before issuance of a final ASU. We are primarily concerned about three key issues, each of which is addressed in more detail in Appendix B: The lack of clarity regarding when the practical expedient may be elected The following are examples of where we suggest additional clarifications, as further described in Appendix B: o o We recommend amendments to ASC A(a) to clarify how and to what extent the timing and pattern of revenue recognition for a lease component and nonlease components associated with that lease component must be the same. We suggest that the Board either (1) amend the final ASU s Basis for Conclusions to clarify why the lessor practical expedient is limited to operating leases in ASC A(b) or (2) reconsider why the lessor practical expedient only applies to operating leases. Uncertainty related to the interaction of the proposed ASU with existing guidance in ASC 842 We think that the Board should provide additional guidance to help clarify how an entity would apply the proposed ASU to (1) the measurement and allocation of variable consideration related entirely to the lessor s efforts to transfer, or an outcome from transferring, goods or services that are not leases, as required in ASC ; (2) whether the lessor practical expedient applies to one or more, but not all, nonlease components associated with a lease component; and (3) lease classification specifically, the guidance in ASC (d) and ASC (b). Accounting for contracts that are predominantly for the delivery of services entirely within ASC 842 In circumstances in which the contract is significantly concentrated in the delivery of nonlease goods or services, no similar expedient is available for an entity to combine the lease component with the nonlease component(s) and account for the entire arrangement in accordance with ASC 606. Therefore, we are uncertain about how helpful the lessor practical expedient will be for reducing the cost and complexity of applying ASC 842 for entities that enter into such arrangements that are predominantly nonlease contracts with a

5 Page 5 customer. Accordingly, we would support a corresponding change to allow an entity to account for such arrangements entirely in accordance with ASC 606 when the contract is predominantly for the delivery of goods or services that are not leases. The above concerns are further discussed in Appendix B. We strongly encourage the Board to consider our comments as well as the need for additional stakeholder outreach. Question 5: Would the information in the financial statements, including disclosures, provided by lessors electing the practical expedient in this proposed Update be decision useful? If not, please explain why. We agree that the additional information in the financial statements and the proposed ASU s disclosure requirements for entities electing the lessor practical expedient are useful. For an entity applying the lessor practical expedient, the timing and pattern of revenue recognition for the lease component must be the same as those for the nonlease component(s) associated with that lease component. Accordingly, whether an entity elects the lessor practical expedient or chooses to separate and allocate the lease and nonlease components is generally only a matter of presentation and disclosure. Since the use of the lessor practical expedient will reduce information about otherwise separate revenue streams on the face of the income statement, we support the proposed ASU s additional requirements for entities electing the lessor practical expedient to disclose (1) the accounting policy election and (2) the nature of the nonlease components included in the single lease component(s).

6 Page 6 Appendix B Other Comments Comment 1 Application of ASC When the Lessor Practical Expedient Is Elected We are uncertain about the interaction of the proposed ASU with the existing guidance in ASC , which states: The consideration in the contract for a lessor includes all of the amounts described in paragraph and any other variable payment amounts that would be included in the transaction price in accordance with the guidance on variable consideration in Topic 606 on revenue from contracts with customers that specifically relates to either of the following: a. The lessor s efforts to transfer one or more goods or services that are not leases b. An outcome from transferring one or more goods or services that are not leases. Any variable payment amounts accounted for as consideration in the contract shall be allocated entirely to the nonlease component(s) to which the variable payment specifically relates if doing so would be consistent with the transaction price allocation objective in paragraph [Emphasis added] When electing the lessor practical expedient, an entity would combine the nonlease component(s) with the corresponding lease component to create one unit of account. That is, the entity is not required to identify nonlease component(s) for separate accounting, even though the lessor would be aware that it is obligated to transfer goods or services that are not leases to the lessee (i.e., because it priced the contract and is the primary obligor of all performance obligations in the arrangement). However, it is unclear what consideration in the contract would apply to the combined lease component, given that ASC would not be amended by the proposed ASU and would continue to state that an entity must identify, estimate, constrain, and include variable consideration that is entirely related to efforts to transfer, or the results of transferring, goods or services. That is, it is unclear whether an entity would still need to identify goods or services when determining the consideration in the contract under ASC It is also therefore unclear how variable consideration entirely related to goods or services would be allocated when a contract contains multiple lease components. Without further clarification, some may believe that, given the interaction between ASC A and ASC , a lessor is required to proceed through the following steps when electing the lessor practical expedient: 1. Lessors may elect not to separately account for nonlease components. However, they must still separate lease components when required to do so by ASC and Lessors that elect the practical expedient would not apply the guidance in ASC since those lessors are no longer accounting for separate nonlease components in the contract for which variable payment amounts would be estimated (and constrained) and to which variable payment amounts would be

7 Page 7 allocated. The lessor is alleviated from the requirement to identify goods or services that are not leases and from determining whether variable consideration that is entirely related to those goods or services must be measured in accordance with ASC 606 and included in the consideration in the contract. 3. The consideration in the contract must be allocated between the lease components on the basis of stand-alone selling prices. If the nonlease components are combined with the associated lease components, there are no separate nonlease components to which the variable consideration may be entirely allocated as the end of ASC would otherwise indicate. Therefore, in the period when the changes in facts and circumstances upon which variable payments are based occur, the variable payments are allocated on the same basis of stand-alone selling prices as is used to allocate to any fixed consideration in the contract between the lease components. For example, assume that a lessor elects the practical expedient and, as a result, a contract containing two lease components and one nonlease component is accounted for as two lease components: the first lease component, with which the associated nonlease component is combined, and a second lease component (which would be classified as a sales-type lease). The contract contains $100 in lease payments (i.e., fixed consideration) and variable consideration that is entirely related to an outcome of transferring a good or service. We think that, in this scenario, $100 is the consideration in the contract that would need to be allocated between the lease components. Further, assume that the stand-alone selling prices of the lease components indicates that $50 is allocated to the first lease component and $50 is allocated to the second lease component (i.e., resulting in a 50/50 proportionate allocation). Accordingly, as the changes in facts and circumstances upon which the variable payments are based occur, the lessor would also allocate the variable payments between the lease components on a 50/50 basis. We note that the above scenario appears to contradict the allocation objective in ASC In the example above, the variable consideration is entirely related to the transfer of goods or services (which are now accounted for as part of the first lease component), yet the first lease component (which contains the goods or services) would only be allocated 50 percent of the variable consideration when the variability is resolved, rather than 100 percent. We suggest that the Board clarify how to apply the guidance in ASC when the lessor practical expedient in ASC A is elected. If the above interpretation is consistent with the Board s intent and if it was the Board s intent that the outcome in such arrangements may not be consistent with the allocation objective in ASC , we think that this should be clarified in the final ASU s Basis for 1 ASC states, in part, that [a]ny variable payment amounts accounted for as consideration in the contract shall be allocated entirely to the nonlease component(s) to which the variable payment specifically relates if doing so would be consistent with the transaction price allocation objective in paragraph ASC states that [t]he objective when allocating the transaction price is for an entity to allocate the transaction price to each performance obligation (or distinct good or service) in an amount that depicts the amount of consideration to which the entity expects to be entitled in exchange for transferring the promised goods or services to the customer.

8 Page 8 Conclusions. If the above interpretation is inconsistent with the Board s intent (e.g., if it would be appropriate to allocate the variable payments entirely to the first lease component, even though the goods or services are not separately identified), we think that ASC should be amended to reflect that. Comment 2 Suggested Clarifications and Amendments With Respect to ASC A(a) and 15-42A(b) ASC A(a) Under ASC A(a), for an entity to apply the proposed lessor practical expedient, the timing and pattern of revenue recognition for the lease component and nonlease components associated with that lease component must be the same. As currently written, this paragraph is unclear on whether the Board intended to require that (when lease income is recognized by using a time-based method of measuring progress) the timing and pattern of the revenue recognition for the nonlease component be on a straight-line basis. Through discussions with the FASB staff, we previously came to understand that, for operating leases, ASC (a) and paragraph BC327 of ASU were not intended to require or permit a lessor to deviate from straight-line income recognition of an operating lease when uneven rents are designed to reflect market conditions. Accordingly, in a manner similar to their current accounting under ASC 840, lessors will continue to recognize rental income from operating leases on a straight-line basis. Therefore, if the Board intended to limit the lessor practical expedient to arrangements in which the timing and pattern of revenue recognition for the nonlease component are on a straight-line basis, we suggest that the Board provide that clarification. We also recommend that the Board clarify when an arrangement that contains variable lease payments that are not based on an index or rate may meet the criterion in ASC A(a). In accordance with ASC (b), variable lease payments that are not based on an index or rate are recognized as income in profit or loss in the period in which the changes in facts and circumstances on which the variable lease payments are based occur. Therefore, it is uncertain whether (or to what extent) the timing and pattern of revenue recognition for the nonlease component(s) must also be consistent with the timing and pattern indicated in ASC (b). We question whether, whenever an arrangement contains any amount of variable lease payments, an entity would need to apply the revenue model in ASC 606 to determine that the timing and pattern of revenue recognition are the same. That is, we question whether an entity would need to consider only step 5 of the revenue model (e.g., it is sufficient that the method of measuring progress of a performance obligation satisfied over time is consistent with the general straight-line basis of recognizing lease income on an operating lease) or steps 3 5 of the revenue model (e.g., the measurement and timing of revenue recognized from variable payments must be consistent for the lease component and the nonlease component, even though ASC 842 and ASC 606 have different measurement models for variable consideration). For example, it is unclear whether the lessor practical expedient may be applied when, under ASC 606, the measurement, timing, and pattern of revenue recognition for the nonlease component(s) are even or straight-line (e.g., because a time-based method is used to measure progress toward complete satisfaction of a performance obligation that is satisfied over time) and variable lease payments are associated with the lease component (i.e., that are not recognized on an even or straight-line basis).

9 Page 9 Lastly, while the condition in ASC A(a) refers to the timing and pattern of revenue recognition, it is unclear whether the Board has considered the cost profile associated with the components for which the lessor practical expedient is elected. Since the lessor practical expedient is meant to be applied when the financial reporting impact of combining lease and nonlease components would be limited to presentation and disclosure, we think it follows that the net income timing and pattern should be the same. Because of the lack of guidance in ASC 842 on lessor fulfillment costs, we understand that there are diverse views in practice about whether a lessor should capitalize fulfillment costs (which are different from initial direct costs) associated with a lease and, if so, what capitalization model is appropriate. For example, it is unclear whether ASC may be applied when the contract contains only a lease component. Accordingly, fulfillment costs may be treated differently depending on whether a nonlease component is (1) separated and accounted for under ASC 606 or (2) combined with a lease component by using the proposed lessor practical expedient. As a result, we think that electing the lessor practical expedient has the potential to change the net income profile of the overall arrangement, which seems contrary to the Board s intent. We think that the Board should consider this further and either (1) incorporate a consideration of costs into the condition in ASC A(a) or (2) clarify that the condition in ASC A(a) is limited to a consideration of the timing and pattern of revenue recognition (i.e., that it does not involve a consideration of the timing and pattern of associated costs). If the Board chooses to leave the wording as is and limit the condition to a consideration of revenue recognition, we think that the rationale for ignoring costs (i.e., ignoring the timing and pattern of the arrangement s net income) should be addressed in the Basis for Conclusions. In summary, we acknowledge that through the guidance in ASC A(a), the Board is attempting to define what is effectively a set of scoping criteria for applying the lessor practical expedient. As noted in our responses to the proposed ASU s questions for respondents, we generally support the Board s proposal to amend ASC 842 to provide lessors with an optional practical expedient. However, we would like to further understand to what extent the timing and pattern of revenue recognition for a lease component and nonlease components associated with that lease component must be the same. In paragraph BC24 of the proposed ASU, the Board provided an acceptable basis for determining whether the requirements for applying the proposed ASU are met, without having to apply the separation and allocation guidance. As outlined above, we think that there are still areas that are open to interpretation with respect to determining that the timing and pattern of revenue recognition are the same (e.g., arrangements that do not have straight-line income recognition or that contain variable lease payments that are not based on an index or rate). ASC A(b) We recommend that the Board clarify why the ability to use the lessor practical expedient is limited to operating leases, as stated in ASC A(b). We think that there could be a rationale for applying the lessor practical expedient to leases whose classification does not change as a result of application of the expedient. Consider an example in which an entity provides for the right to use hardware with a corresponding software license in a contract. The license represents a right to use functional intellectual property (IP), which has a point-in-time revenue recognition pattern under ASC B. The right to use the hardware is a lease. The classification test under ASC 842 indicates that the lease component, alone, is a sales-type lease. The classification test of the lease component, when combined with the nonlease component, also results in a salestype lease. The timing and pattern of revenue recognition for the hardware and software license are the same. That is, profit or loss is recognized at a point in time and interest income

10 Page 10 is recognized to reflect the financing for the hardware (and potentially for the license as well, depending on the facts and circumstances of the arrangement). The way the language in ASC A(b) is currently drafted, that entity would be excluded from applying the lessor practical expedient, since the lease is classified as a salestype lease before, and after, the nonlease component is combined with the lease component. We think that the Board should consider whether the entity should be permitted to apply the lessor practical expedient if (1) the timing and pattern of revenue recognition for the nonlease component(s) and related lease component are the same and (2) the classification does not change as a result of the combination of the nonlease component(s) with the associated lease component. In summary, the lessor practical expedient, as proposed, is not available to entities with a lease classified as other than an operating lease, regardless of whether the original classification is retained upon the combination of the nonlease component(s) with the associated lease components. We encourage the Board to either (1) conduct additional stakeholder outreach to determine whether amending the guidance to allow for the application of the practical expedient when lease classification does not change would both be helpful in reducing the cost and complexity of applying ASC 842 and provide decision-useful financial statement information about affected arrangements or (2) enhance its rationale for this conclusion in the final ASU s Basis for Conclusions. Comment 3 Application of the Lessor Practical Expedient to One or More, but Not All, Nonlease Components Associated With a Lease Component Questions have arisen about whether a preparer can elect to apply the lessor practical expedient to one or more, but not all, nonlease components associated with a lease component. Paragraph BC21 of the proposed ASU addresses this question in part, stating that [i]f an entity elects the practical expedient in this proposed Update, it must apply the expedient consistently to all nonlease components eligible to be combined with lease components (emphasis added). However, under the lessor practical expedient, it is unclear whether an entity may (1) combine one or more, but not all, nonlease components with a related lease component when the criteria in ASC A are met and account for the combined unit of account as a single lease component and (2) account for the other nonlease component(s) that does (do) not meet the criteria in ASC A separately in accordance with ASC 606. For example, in a common vehicle lease arrangement, a lessor may agree to offer the customer, in addition to the lease, roadside assistance services and participation in a loyalty program. It is reasonable to consider that the revenue recognition patterns of the vehicle lease and the roadside assistance services may be the same, but the revenue recognition pattern associated with the loyalty program is unlikely to be. We are uncertain whether the lessor may apply the practical expedient to combine the lease and the nonlease component for the roadside assistance while separating the nonlease component for the loyalty program and accounting for it in accordance with ASC 606. We think that entities should be able to apply the lessor practical expedient to one or more, but not all, nonlease components associated with a lease component when the criteria in ASC A are met for one or more, but not all, nonlease components. We recommend that the Board amend the proposed guidance to address

11 Page 11 the application of the lessor practical expedient in such circumstances because doing so would be consistent with: 1. The guidance in ASC 606, and specifically, paragraph BC116 of ASU Paragraph BC116 clarifies that an entity is not precluded from accounting for otherwise distinct goods or services as if they were a single performance obligation when the accounting outcome is the same as if the goods or services had been separated into individual performance obligations. For the treatment described in paragraph BC116 of ASU to be applied, it is not required that all goods or services have the same timing and pattern of transfer to the customer; that is, some distinct goods or services may be accounted for as if they were a single performance obligation while other distinct goods or services are accounted for as separate performance obligations. 2. The Board s efforts to reduce the cost and complexity of implementing ASC 842. Amending the proposed guidance in this manner would increase the number of entities that may avail themselves of the lessor practical expedient and of contracts to which the lessor practical expedient may be applied. Comment 4 Determination of Whether a Contract Should Be Accounted for Entirely Under ASC 842 or Entirely Under ASC 606 We acknowledge that paragraph BC25 of the proposed ASU specifically does not limit the practical expedient on the basis of the magnitude or significance of the nonlease component relative to the overall contract. We understand that the Board thought that adding such a requirement may increase the level of complexity that the proposed lessor practical expedient was designed to reduce. However, we encourage the Board to further clarify why it is preferable for a contract that contains a large service (nonlease) component and a relatively minor lease component (i.e., a big service/small lease ) to be accounted for entirely under ASC 842, as opposed to providing an option for suppliers to account for the entire contract under ASC 606. For example, in certain arrangements to provide tenants with accommodations in a health care or retirement community, the nonlease components may represent a significant portion (e.g., 80 percent) of the value of the contract. In addition, the lease and nonlease components may have the same patterns of revenue recognition (e.g., when the lease component is an operating lease, the nonlease components represent stand-ready obligations, and the progress toward satisfying the performance of the stand-ready obligations is time-based). If the lease component, when combined with the nonlease components, would be classified as an operating lease, a lessor may apply the practical expedient to combine the components into a single lease component accounted for under ASC 842. However, in this case, the value of the contract is significantly concentrated in the nonlease service components, yet no similar expedient is available for an entity to combine the lease component with the nonlease components and account for the arrangement in accordance with ASC 606. Therefore, we are uncertain about how helpful the practical expedient will be to entities that enter into such arrangements and whose users would be provided with more decision-useful information by accounting for,

12 Page 12 presenting, and disclosing the arrangement as a contract with a customer (i.e., under ASC 606). We further acknowledge that if an entity could apply a similar expedient to account for such arrangements entirely in accordance with ASC 606, the entity would need to differentiate between arrangements that are best accounted for entirely under ASC 842 and arrangements that are best accounted for entirely under ASC 606. However, we also recognize that the Board has produced a standard-setting solution for a similar circumstance under ASC 606, in arrangements that contain a license of intellectual property and other promised goods or services that are not separated into distinct performance obligations. That is, the guidance in ASC A (as added by ASU ) requires an entity to consider whether a license of intellectual property is the predominant item before applying the sales- and usage-based royalty constraint in ASC We think that, if such a line needed to be drawn, a similar concept could be applied to determine whether the predominant item in the contract is a lease component or a nonlease component and, provided that the components meet the criteria proposed in ASC A, whether the accounting for the combined unit of account should be governed by ASC 842 or ASC 606, respectively. We think that this option will provide more decision-useful financial reporting information for financial statement users of entities in a number of industries when those entities would otherwise have used the proposed lessor practical expedient to account for significant service contracts entirely under ASC 842. We recognize that such an additional practical expedient would be an option and not a requirement and that an entity could therefore choose to account for the nonlease component under the new revenue guidance. In summary, we encourage the Board to perform additional outreach with affected stakeholders (i.e., those preparing, auditing, and using financial information about big service/small lease arrangements) and consider whether amending the proposed ASU to provide an option for such arrangements to be treated entirely under ASC 606 would produce more decision-useful information. Comment 5 Election of an Accounting Policy for Revenue-Generating Activities by Class of Underlying Asset As written, ASC A requires that the proposed lessor practical expedient be elected as an accounting policy by class of underlying asset. We recognize that the lessor practical expedient is therefore consistent in this manner with the lessee practical expedient in ASC However, we do not think that an accounting policy election that is applied to revenuegenerating activities should be made by class of underlying asset. Asset class is a more useful differentiation point for lessees, which would apply the practical expedient in ASC to an expense item. On the other hand, asset class is generally not indicative of how lessors contract to generate revenue.

13 Page 13 Rather, we think that the lessor practical expedient should be applied to contracts with similar characteristics and in similar circumstances, in a manner consistent with other revenue-generating activities under (1) the guidance in ASC , which emphasizes consistency in an entity s application of ASC 606 (e.g., throughout its use of practical expedients, such as that in ASC ) and (2) the portfolio approach in ASC Accordingly, accounting policies about similar revenue-generating activities would be considered and elected in a consistent manner, which makes the use of such practical expedients and approaches under ASC 606 and ASC 842 easier for users of financial information to understand. We recommend that the FASB conduct additional outreach with stakeholders about whether the following change to the proposed guidance in ASC A would be more helpful in reducing the costs and complexity associated with applying ASC 842 (deletion in strikethrough; additions underlined): As a practical expedient, a lessor may, as an accounting policy election, by class of underlying asset for contracts with similar characteristics and in similar circumstances, choose to not separate nonlease components from lease components and, instead, to account for each separate lease component and the nonlease components associated with that lease component as a single lease component if both of the following are met: a. The timing and pattern of revenue recognition for the lease component and nonlease components associated with that lease component are the same. b. The combined single lease component is classified as an operating lease in accordance with paragraphs through Comment 6 Application of the Classification Tests in ASC (d) and ASC (b) in the Assessment of the Criterion in ASC A(b) ASC requires that, in determining lease classification, the lessor classify a lease as a sales-type lease when certain criteria are met, including the criterion in 25-2(d), which states that [t]he present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease... equals or exceeds substantially all of the fair value of the underlying asset. In addition, ASC (b) requires the lessor to classify a lease as a direct financing lease when [t]he present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments... and/or any other third party unrelated to the lessor equals or exceeds substantially all of the fair value of the underlying asset. We suggest that the Board clarify how an entity should apply the guidance in ASC (d) and ASC (b) to determine whether the present value of the lease payment represents substantially all of the fair value of the underlying asset when the lessor practical expedient is elected. If the lessor practical expedient is elected, the lessor will not separate payments for the use of the underlying asset from payments for the other promised goods or services provided. As written, the standard does not explicitly indicate whether, by electing the lessor practical expedient, payments for the nonlease component would now be considered lease payments as defined in ASC 842. In addition, it is unclear whether, when the lessor practical expedient is elected, the fair value of the underlying asset should take into account only the fair value of the leased

14 Page 14 asset or also the fair value of the goods or services provided. The latter would ensure an apples-to-apples comparison in that payments for both the lease and other promised goods and services would be compared with a fair value that takes into account both the leased asset and the goods or services provided. If the guidance in ASC (d) and ASC (b) is not clarified, we would interpret it as requiring with respect to the assessment of the criterion in ASC A(b) the comparison of (1) the present value of all payments that would meet the definition in ASC 842 of lease payments even if they are not solely in return for the leased asset (e.g., all fixed payments, regardless of whether they are clearly for the lease or the other promised goods or services) and (2) the fair value of the underlying leased asset without contemplation of the fair value associated with the other promised goods or services. This interpretation is generally consistent with how we would apply the guidance in ASC (d) for lessees when the practical expedient in ASC is elected. If our interpretation described above is not consistent with the Board s intent, we would suggest that the Board further clarify how the guidance in ASC (d) and ASC (b) should be applied to the assessment of the criterion in ASC A(b). We acknowledge that no additional guidance is offered to lessees that elect the practical expedient in ASC However, we think that this matter, if left open to interpretation, could lead to inconsistent application and, potentially, opportunities for abuse (e.g., to the extent that lessors want to achieve an operating lease classification to meet the criterion in ASC A(b)). If additional guidance is provided to lessors electing the practical expedient, we would suggest that the standard also be amended to allow lessees that elect the practical expedient in ASC to apply a consistent approach. Comment 7 Amendments to ASC , Example 12, Case C We note that the proposed ASU would not amend the fact and circumstances of ASC and (Example 12, Case C) to reflect that the example would only be relevant when the lessor practical expedient is not elected. (However, we also note that the facts and circumstances in the example also do not state that the lessee practical expedient in ASC is not elected.) At a minimum, we suggest that the Board amend the example to specify that it is assumed that the lessor is not electing to apply the lessor practical expedient in ASC A. Accordingly, we suggest that the FASB consider the following amendment to ASC (additions underlined): Case C Common Area Maintenance Assume the same facts and circumstances as in Case B (paragraph ), except that the lease is of space within the building, rather than for the entire building, and the fixed annual lease payment of $13,000 also covers Lessor s performance of common area maintenance activities (for example, cleaning of common areas, parking lot maintenance, and providing utilities to the building). Consistent with Case B, the taxes and insurance are not components of the contract. However, the common area maintenance is a component because Lessor s activities transfer services to Lessee. That is, Lessee

15 Page 15 receives a service from Lessor in the form of the common area maintenance activities it would otherwise have to undertake itself or pay another party to provide (for example, cleaning the lobby for its customers, removing snow from the parking lot for its employees and customers, and providing utilities). The common area maintenance is a single component in this contract rather than multiple components, because Lessor performs the activities as needed (for example, plows snow or undertakes minor repairs when and as necessary) over the same period of time. This example does not contemplate whether the lessor would have qualified for the accounting policy election described in paragraph A and assumes no such election was made Therefore, the contract in Case C includes two components a lease component (that is, the right to use the building) and a nonlease component. The consideration in the contract of $65,000 is allocated between those 2 components; the amount allocated to the lease component is the lease payments in accounting for the lease.