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On July 19, 2021, FASB issued Accounting Standards Update (ASU) 2021-05, Lessors – Certain Leases with Variable Lease Payments. The ASU updates guidance in Accounting Standards Codification (ASC) 842, Leases, to restore long-standing accounting practice for certain sales-type leases with variable payments. Early adoption is permitted. 

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As issued, ASC 842 required that a lessor determine whether a lease should be classified as a sales-type lease at lease commencement based on specific criteria. A lessor was not permitted to estimate most variable payments and exclude variable payments that are not estimated and do not depend on a reference index or a rate from the lease receivable. The excluded variable payments are recognized entirely as lease income when the changes in facts and circumstances on which those variable payments are based occur. Consequently, the lease receivable for some sales-type leases with variable payments that do not depend on a reference index or a rate may be less than the carrying amount of the underlying asset derecognized at lease commencement, resulting in the lessor recognizing a loss at lease commencement—a day-one loss—even if the lessor expects the arrangement to be profitable overall.

Some stakeholders felt that recognizing a day-one loss for these leases does not represent the underlying economics either at lease commencement or over the lease term. These arrangements are most prevalent in the energy industry, particularly solar and wind generation companies. Under previous ASC 840 guidance, lessors did not recognize an immediate loss because of the long-standing practice to account for leases with substantial variable payments as operating leases based on an interpretation of ASC 840’s classification criterion. That classification criterion was not retained in ASC 842.

FASB’s intention during deliberations was not to change lessor accounting; however, the final codification had the unintended consequence of changing long-standing practice. Under ASU 2021-05, a lessor would classify a lease with variable lease payments that do not depend on an index or rate as an operating lease at lease commencement if:

  • The lease would have been classified as a sales-type lease or direct financing lease under ASC 842 classification criteria 
  • The lessor would have recognized a selling loss at lease commencement

Effective Date & Transition 

ASU 2021-05 is effective for fiscal years beginning after December 15, 2021, for all entities, and interim periods within those fiscal years for public business entities and interim periods within fiscal years beginning after December 15, 2022, for all other entities.

Entities that have not adopted ASC 842 on or before the issuance date of this Update should follow the transition requirements of ASC 842:  

  • Retrospective to each prior period presented in the financial statements with the cumulative effect of transition recognized at the beginning of the earliest period presented  
  • Retrospective to the beginning of the period of adoption with a cumulative effect of transition recognized at the beginning of the period of adoption

Entities that have already adopted ASC 842 can choose to apply ASU 2021-05 either: 

  • Retrospectively to leases that commenced or were modified on or after ASC 842 adoption 
  • Prospectively to leases that commence or are modified on or after the date that an entity first applies ASU 2021-05

Earlier application is permitted.

Other Lease Updates  

Discount Rate

On June 16, 2021, FASB issued an exposure draft to provide relief to private companies, all not-for-profit (NFP) entities (whether or not they are conduit bond obligors), and all employee benefit plans in determining the discount rate to use under ASC 842. The proposal addresses two issues that were raised in the September 2020 public roundtable sessions:  

  • Changing the existing accounting policy election to use a risk-free rate from entitywide to asset class
  • Clarifying that a lessee using the discount rate accounting policy election must use the rate implicit in the lease when it is readily determinable instead of the risk-free rate

Comments were requested by July 16, 2021. There was broad support for this proposal and a final ASU will be issued shortly. 

Modifications – Part of Post-Implementation Review

An October 2020 exposure draft would have exempted entities from applying modification accounting to the remaining lease components within a lease contract for transactions in which one or more lease components are terminated before the end of the lease term and that early termination does not economically affect the remaining lease components.  Respondents did not disagree with this approach but raised additional modification issues. FASB decided not to address these issues in a piecemeal fashion, but rather would expand research as part of ASC 842’s post-implementation review process. 


The adoption of ASC 842 will be complex and likely will require significant hours to correctly implement. BKD can help educate your team, provide implementation tools, and assist with analysis and documentation. If you would like assistance in complying with the new lease standard, contact your BKD Trusted Advisor. BKD has prepared a library of BKD Thoughtware® on this issue. Visit our Lease Accounting Resource Center to learn more.  

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