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Effective date and transition

Question 10-4

Does a reporting entity need to reassess unamortized initial direct costs at transition to determine if
they meet the new definition of initial direct costs in ASC 842?

PwC response
If a reporting entity elects the package of practical expedients in ASC 842-10-65-1(f) for all leases as of
the effective date, it does not need to reassess whether initial direct costs meet the new definition at
the initial application date. Otherwise, a reporting entity will need to reassess the initial direct costs
under the new leases guidance and should account for the balances that no longer meet the definition
as explained in the subsequent section.

Consequences of not electing the package of practical expedients

Reporting entities that do not elect the package of practical expedients will need to reassess all
arrangements to determine if they meet the definition of a lease or contain an embedded lease under
the new leases guidance. They will also need to assess lease classification using the new criteria for all
contracts that meet the definition of a lease under the new guidance and determine whether or not
certain prior expenditures meet the new narrower definition of initial direct costs.

When the reporting entity does not apply the package of practical expedients, it will need to reallocate
consideration as of the lease commencement date for any contract that contains a lease component in
order to reassess lease classification. If the entity is not electing the hindsight practical expedient, this
allocation would start with the same lease payment data as used under ASC 840 (for example,
reflecting the same lease term as what was used under ASC 840). The lease payment data should be
updated to include amounts allocated to lease components under ASC 842 (for example, property
taxes and insurance related to the leased asset should be included in the contract consideration and
allocated to lease components). Classification is then reassessed as of the lease commencement date. If
the classification of the lease component does not change, then the measurement of the lease upon
adoption of ASC 842 would use ASC 840’s definition of payments; in other words, the entity would
revert to the amounts allocated to lease components under ASC 840.

When a reporting entity makes an accounting policy election to not separate nonlease components
other than executory costs from the associated lease component at transition, a reallocation for
nonlease components is not required in transition, as discussed in LG 10.4.1.2. When a reporting
entity elects to account for nonlease components other than executory costs as part of the lease
component, it is more likely that lease classification will change (due to a potential increase in the
amounts considered to be lease payments).

If a reporting entity does not elect the package of practical expedients in ASC 842-10-65-1(f), any
unamortized initial direct costs at the initial application date that do not meet the new definition of
initial direct costs in ASC 842 should generally be written off as an adjustment to equity at the
application date (or to earnings when incurred for leases that commenced during the look-back period
when comparative periods are adjusted) in accordance with ASC 842-10-65-1(p) and ASC 842-10-65-
1(v)(3). However, for lessees with capital leases under ASC 840 that remain as finance leases under
ASC 842, only such initial direct costs not included in the measurement of a capital lease asset under
ASC 840 should be written off in accordance with ASC 842-10-65-1(r)(3). Similarly, for lessors with
direct financing leases under ASC 840 that are either direct financing leases or sales-type leases under

10-7