18 Aug 2020 Lessee Options for Lease Concessions Stemming from COVID-19
Due to the coronavirus pandemic, the FASB pushed back the effective date for the new lease accounting standard (ASC 842) for companies who have not yet adopted the standard to January 1, 2021. However, many companies have early adopted or began to implement the new leasing standard before the determination was made to delay the effective date. ASC 842 requires the lessee to recognize a right-of-use (ROU) asset and lease liability for both finance and operating leases. ASC 842 also provides guidance for modification to lease agreements that arise when changes to lease payments are made that are not stipulated in the original lease contract. Due to the COVID-19 pandemic, numerous lessors have provided lease concessions for various reasons, leaving many to wonder how these should be accounted for under the new lease guidance.
On April 8, 2020, the FASB met to address the issue. They determined that the guidance was written with the normal course of business in mind and did not consider widespread lease concessions due to the economic ramifications of a global pandemic. Acknowledging the difficulty and costliness that would arise from millions of lessees determining if concessions were lease modifications as described under ASC 842 and then adjusting their books accordingly, the FASB has allowed entities to elect to account for concessions related to the effects of COVID-19 as though enforceable rights and obligations for those concessions existed in the original contract. This makes the process much simpler and cost-effective at a time where companies don’t have the resources to do a full reevaluation of their contracts. To make this election, the following conditions must be present:
- The lease concession is directly due to the financial conditions caused by the COVID-19 pandemic.
- The concessions do not result in a substantial increase in the rights of the lessor or the obligations of the lessee.
The FASB did not define “substantial,” leaving it up to the judgment of the parties involved. Though a lessee’s concessions may meet these conditions, they are not required to make the election. This election is available for both operating and finance leases, if the conditions are met.
The most common lease concessions allowed by lessors are the deferral of rent payments to either a later date or spread across future dates, rent abatements, and lease term extensions in exchange for rent forgiveness in the short term. All of these have the potential to fall under the election. In each case, disclosures of material concessions and the election of how to treat them should be made in the notes to a company’s financial statements.
How should a lessee treat a lease concession they have received from a lessor?
Situation 1 – The lessee chooses the election allowed by the FASB.
There are several paths to choose once a lessee has determined they meet the necessary conditions for the election. This list is not exhaustive, and it is recommended to consult with an accounting professional to determine the acceptability of each option as well as other alternatives.
- Record deferred payments as payables. In this method, the lessee would treat the lease as if no changes had taken place – do not revalue the ROU asset and lease liability and continue to amortize them on a straight line over the original lease term. However, during a period with a deferred payment, the lessee would record a payable liability for the amount of cash payment being deferred to a later date. That liability would remain on the books until paid in accordance with the concession terms.
- Record deferred payments as “negative” variable rent expense. This is like the first option – the original ROU asset and lease liability are continued to be amortized on a straight line over the original term. However, instead of recording a payable for the deferred cash payment, the lessee would record a “negative” (or credit) variable rent expense. When the deferred payment is made, the lessee would recognize variable rent expense equal to that deferred payment.
- Remeasure the ROU asset and lease liability consistent with resolving a contingency. This method may be more desirable when concessions are given other than deferred payments. This allows the lessee to revalue the ROU asset and lease liability without needing to update the discount rate used in initial measurement or reassess the classification of the lease between operating or finance. The lease liability would be adjusted according to the revised lease payment schedule and the original discount rate, and the ROU asset would be adjusted accordingly.
Situation 2 – The lessee does not elect the option provided by the FASB, or one or both required conditions are not met.
In this situation, the lessee would need to account for the concessions as a lease modification under ASC 842. When accounting for a modification in a lease, the lessee must revalue the ROU asset and lease liability based on the updated terms and conditions. The lease may need to be reclassified from operating to finance (or vice versa) depending on the updated terms, and a new separate ROU asset may need to be recognized for any additional rights given to the lessee under the new terms.
If you have been given a lease concession and want to know the correct and most effective way to treat it for your business, or have questions on implementing the new lease accounting standard please contact your Haynie CPA or Brad Bickmore, CPA at BradB@HaynieCPAs.com.