Perspectives

Assessing the collectibility of operating lease receivables

Financial Reporting Alert 19-1

This alert addresses the questions that have arisen about how entities that have adopted the FASB’s new leasing standard, ASC 842, should account for the collectibility of operating lease receivables that are or are expected to become impaired. The alert notes that the FASB’s staff has indicated that entities must apply the guidance in ASC 842-30 that requires an assessment of the probability of payment, and they may supplement that guidance with the use of a general or portfolio reserve approach. Consistent application and transparent disclosure of the policy elected are critical.

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While adopting ASC 842, lessors have raised questions about the appropriate accounting for operating lease receivables recognized by a lessor that are or are expected to become impaired since they are excluded from the scope of the new impairment guidance in ASC 326. On the basis of a technical inquiry with the FASB staff, we understand the following:

  • The application of the guidance in ASC 842-30 requiring an assessment of the probability of an individual customer’s (tenant’s) future payment is mandatory.
  • A lessor may elect to supplement the ASC 842-30 guidance with the use of a general or portfolio reserve approach (aligned with the legacy application of ASC 450-20).
  • If a lessor elects to record a general reserve, the income statement impact may be recorded as a reduction to lease income or as bad-debt expense.
  • Given the expected diversity in practice, consistent application and transparent disclosure of the policy elected are critical.Insert excerpt from the FRA, typically the introduction/background portion.
FRA 19-1 | July 1, 2019

Background

In June 2016, the FASB issued ASU 2016-13, which adds to U.S. GAAP an impairment model — known as the current expected credit loss (CECL) model — that is based on change the accounting for credit impairment under ASC 326.

In November 2018, the FASB issued ASU 2018-19 to clarify certain aspects of ASU 2016-13, including that operating lease receivables are not within the scope of ASC 326-20. Instead, an entity would need to apply other U.S. GAAP to account for changes in the collectibility assessment for operating leases.

Although ASU 2018-19 amended only ASC 326, which is not effective for calendar-year public business entities until January 1, 2020, we believe that the Board’s clarification that operating lease receivables are within the scope of other guidance, namely ASC 842, rather than ASC 326 may result in a change in how some lessors account for the collectibility of operating lease receivables upon the adoption of ASC 842. We understand that there is currently diversity in practice in how some lessors account for credit losses related to operating lease receivables under ASC 840. Specifically, under current practice, certain lessors account for the collectibility of operating lease receivables in a manner consistent with the way they account for the collectibility of trade receivables (i.e., recognize an allowance for uncollectible accounts and a corresponding bad-debt expense), whereas other lessors account for these credit losses as an adjustment to the related lease income.

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