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Effective date and transition

When applying hindsight for an operating lease with non-level rents, we believe a lessee or lessor
should apply the updated lease term by starting at the lease commencement date and recalculating
what the accrued/deferred rent balances would have been as of the application date of the new leases
guidance if the lease term known as of the effective date had been known at commencement. The
lessee or lessor should record any difference between the prior and adjusted accrued/deferred
balances as of the application date as an adjustment to opening equity.

Question 10-5
Does the election of hindsight by a reporting entity require the entity to undertake a fresh assessment
of the facts and circumstances that are relevant in determining the lease term even if there have been
no triggering events?

PwC response
We believe a reporting entity should undertake a fresh assessment of the facts and circumstances
when applying the hindsight practical expedient, taking into consideration all available information
prior to the effective date that would be relevant in determining the term of the lease. For example,
assume a calendar year-end public company adopts the leases standard on 1/1/2019 and has chosen to
adjust comparative periods (1/1/2017 through 12/31/2018) in transition. The entity has a lease that
commenced prior to 1/1/2017 and the lessee exercised an extension option on 1/1/2018. In this
situation, we believe if the lessee elects hindsight at the time of adoption on 1/1/2019, the lessee
should recognize a lease liability and a right-of-use asset on 1/1/2017 assuming the extended lease
term.

This is the case even if the lessee’s extension option was not exercisable in the look-back period (for
example, if the extension option is only exercisable on or after 1/1/2019) but as of the effective date
(i.e., 1/1/2019) it was reasonably certain that the lessee would exercise the extension option because of
a change in facts and circumstances from the original assessment date. Thus, the extended lease term
should be used.

Question 10-6

What is the lessee transition accounting model for a lease previously classified as a capital lease under
ASC 840 when a lessee elects the practical expedient of hindsight for purposes of adopting the leases
standard?

PwC response
ASC 842-10-65-1(r)(1) prescribes transition guidance for a lessee that has a capital lease under ASC
840 that is classified as a finance lease under ASC 842. Under this guidance, the lessee should
recognize a right-of-use asset and a leases liability at the carrying amount of the lease asset and the
capital lease obligation under ASC 840 at the initial application date. A literal application of this
guidance may result in an anomalous discount rate for a lessee that has a capital lease under ASC 840,
especially if the lessee elects both the package of practical expedients and applies hindsight (to
determine the lease term) when transitioning to ASC 842. The application of hindsight could result in
a shortened (or lengthened) lease term because exercise of a renewal option may no longer be
reasonably certain (or may have become reasonably certain). In this situation, the discount rate
required to amortize the carrying value of the capital lease obligation (determined under ASC 840) to

10-9