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Effective date and transition

the appropriate amount by the end of the shortened (or lengthened) lease term may get significantly
reduced (or increased).

This issue could occur whenever a lessee elects the package of practical expedients as well as the
application of hindsight for its existing operating leases. In that case, the lessee would also need to
apply the expedients to its existing capital leases. Because the lessee elected the package of practical
expedients, it would not reassess lease classification.

Given the transition guidance in ASC 842-10-65-1(r)(1) states that the carrying amount of the capital
lease asset and capital lease obligation under ASC 840 should be carried over into the right-of-use
asset and lease liability, there are circumstances in which a literal application of that guidance in
conjunction with hindsight would produce a materially distorted interest rate. This could result in a
significant impact to subsequent expense recognition. Paragraph BC394 in the Basis for Conclusions
of ASC 842 indicates that the Board intended for the application of the hindsight election to result in
more accurate, updated information for financial statement users. Consequently, we believe a lessee
may apply the following approach to transition existing capital leases when the lessee elects to apply
hindsight:

□ Apply hindsight at the lease inception date to determine the appropriate lease term and discount
rate.

□ Using such discount rate, recalculate the new capital lease asset and capital lease obligation
balance (as well as any deferred initial direct costs balance) under ASC 840 using revised lease
payments as of the initial application date as though the lease term was always the updated lease
term based on hindsight.

□ Any difference between the recalculated and existing balances at the initial application date should
be recorded as an adjustment to opening equity. Note, however, that if the reporting entity has
elected to adjust the comparative periods upon adoption and the lease commenced during the
comparative periods, the adjustment should be reflected in earnings during the comparative
periods.

The lessee should then follow the transition accounting in ASC 842-10-65-1(r) through (t) using the
recalculated balances.

Question 10-7

What is the lessor transition accounting model for a lease previously classified as a sales-type lease or
direct financing lease under ASC 840 when a lessee elects the practical expedient of hindsight for
purposes of adopting the leases standard?

PwC response
We believe that a principle similar to the one described in Question 10-6 would apply for lessors with
sales-type leases and direct financing leases.

The transition guidance in ASC 842-10-65-1(x)(1) requires that a lessor continue to recognize a net
investment in the lease at the carrying amount of the net investment under ASC 840. A literal
application of ASC 842-10-65-1(x) could produce a materially distorted implicit interest rate in certain
cases when a lessor also elects to apply hindsight. This could result in a significant impact to

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