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Effective date and transition

We believe that if the lessee historically disclosed the amount of its commitments for operating leases
with variable payments based on an index or rate using the current index or rate, the lessee may
measure the initial lease liability for its existing leases at transition by either (a) using the current
index or rate consistent with its existing policy for disclosures or (b) using the index or rate at the
inception of the lease consistent with the definition of minimum rent payments in ASC 840. In this
latter case, since the lessee is neither changing its recognition nor disclosure policies for operating
leases, we do not believe that application of ASC 250 is required.

Separation of components in transition – updated December 2018

Under the new leases guidance, a reporting entity is required to separate lease and nonlease
components. However, for new leases on or after the effective date of ASC 842, a lessee may, as an
accounting policy election by class of underlying asset, choose to not separate nonlease components
from the associated lease components and instead account for each separate lease component and its
associated nonlease components as a single lease component. The new leases transition guidance does
not specify whether a lessee can make an accounting policy election to not separate lease and nonlease
components for existing leases in calculating the lease liability at transition.

Under ASC 842, the measurement of the lease liability for an existing operating lease includes the
present value of the remaining minimum rental payments (“as defined in ASC 840”). The term
“minimum rental payments,” however, is not actually defined in ASC 840 and the description of
“minimum lease payments” is unclear. We believe that the treatment of lease and nonlease
components in transition for existing leases depends on whether the lessee elects an accounting policy
under ASC 842 to not separate nonlease components from the associated lease components (see LG
2.4.4.1).

Lessee does not elect to combine nonlease and lease components

A lessee must separate nonlease components (other than executory costs) from the associated lease
components at transition for existing leases if the lessee has not made an accounting policy election to
combine them under ASC 842 for new leases.

When a lease includes executory costs in the fixed rent payments (a gross lease), the guidance in ASC
840 with respect to accounting for those executory costs (such as insurance, maintenance, and
property taxes) to be paid by the lessor is unclear. With respect to a lessee, ASC 840 says that
minimum lease payments include minimum rental payments called for by the lease over the lease term
and comprise payments the lessee is obligated to make in connection with the leased property. As
such, it does not directly address the treatment of executory costs. In the minimum lease payments
classification test, ASC 842 states that executory costs are excluded. As such, the new guidance could
be read to imply that minimum lease payments include executory costs, hence the need to require
their specific exclusion for purposes of the minimum lease payments classification test.

Since the guidance in ASC 840 is unclear, we believe there were two acceptable historical practices for
a lessee to account for an operating gross lease:

□ The lessee could have chosen to separate executory costs from the remainder of the minimum
lease payments or

□ The lessee could have chosen to include the fixed portion of executory costs within minimum lease
payments

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