The COVID-19 pandemic has resulted in significant market uncertainty, business shutdowns, and decreased operations across various business industries. For many of the entities affected by the pandemic, lease-related expenses represent a significant cost to operations. Therefore, entities have negotiated lease concessions with their lessors in order to reduce the economic hardships caused by the pandemic.
These lease concessions often are comprised of lease payment deferrals or payment forgiveness. In response to the growing number of lease concessions being provided, and the lack of clear guideline for the treatment of such lease concessions under ASC 842, Leases, or ASC 840, Leases, the Financial Accounting Standards Board (FASB) has provided supplemental guidance related to the proper treatment of the lease concessions received as a result of the COVID-19 pandemic. While much of the guidance provided by the FASB is provided in the context of ASC 842, this guidance is also applicable to privately held entities operating under ASC 840.
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ASC 840 and ASC 842 Lease Modifications
Although the treatment of changes to lease payments that are not stated in the original lease agreement are accounted for as lease modifications under ASC 842, and applied to privately held entities utilizing ASC 840 for the treatment of the changes to lease payments due to the pandemic, the FASB has provided alternative guidance as the application of these lease modifications may become costly and complex for lessees and lessors. Furthermore, the FASB acknowledges that the recognition of these lease concessions related to the effects of the pandemic may not be reflective of the remaining lease terms.
Under ASC 842 and ASC 840, a lease modification would result in the creation of a new lease agreement upon which the assessment of the lease payment amount for accrual accounting recognition under the new lease terms is to be determined. Accordingly, the FASB has determined that it would be acceptable for entities to make an election to account for lease concessions related to the pandemic as though enforceable rights and obligations for those concessions existed within the original terms of the lease agreement.
In order to apply these accounting elections stipulated by the FASB, it is required that the lease concessions do not result in a substantial increase in the rights of the lessor or obligations of the lessee and the total payments required by the modified contract are substantially the same as or less than the original lease agreement. Therefore, if the preceding condition is met, entities may apply the following methods when accounting for the lease concessions related to the pandemic.
Lease Concessions Resulting in Deferral of Lease Payments
The initial lease concession for which the supplement accounting elections were provided pertained to the deferral of lease payments. This election provides guidance for entities in the treatment of the lease payment deferrals as both ASC 842 and 840 did not explicitly identify the treatment of lease payment deferrals outside the context of the lease modification guidance. Therefore, the FASB identified the following accounting elections for lease payment deferral concessions granted as a result of the pandemic:
- Account for the concessions as if no changes were made to the lease agreement. Therefore, a lessor would record lease income with a lease receivable for the period in which the lease concession is provided. Correspondingly, the lessee would record the lease expense for the period as stated in the original lease agreement with a corresponding lease payable for the deferred payment to be made on the lease agreement.
- Account for the deferred payments as variable lease payments. Under ASC 842, variable lease payments that are not dependent on an index or rate are recognized within earnings (lessor) or expenses (lessee) in the period in which the obligation for those payments is incurred. ASC 840 refers contingent rentals as payments that are dependent on future events and these deferred payments would be recorded under this guidance when the payment is incurred.
Following the account elections identified above, this presents the entity with the option to either accrue the lease earnings (lessor) or lease expenses (lessee) in accordance with the original lease terms with a corresponding lease receivable or lease payable or recognize the rent expense as contingent rent.
The election to record the lease income (lessor) or lease expense (lessee) as contingent rent would eliminate the recognition of the lease expense during the periods in which the concession was granted and require the recognition of the lease income (lessor) or lease expense (lessee) during the period in which the deferred lease payments were incurred. This will result in later periods (when the lease payments are made) to hold greater total lease expenses, as it would include deferred lease payments in addition to the current period lease expense.
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Lease Concessions Resulting in Lease Payment Forgiveness
In addition to the accounting elections provided for lease concessions allowing the deferral of lease payments, the FASB has also provided supplemental guidance for lease concessions that result in the forgiveness in lease payments related to the effects of the pandemic.
Consistent with the lease concessions for the deferral of rental payments, the FASB allows the use of the alternative elections, bearing in mind that the lease concession does not result in a substantial increase in the rights of the lessor or obligations of the lessee and the total payments required by the modified contract are substantially the same or less than the original lease terms. If the preceding condition is met, the entity may choose either of the following accounting elections for the lease payments forgiven:
- Recognition of a negative contingent lease income (lessor) or expense (lessee) in the period of forgiveness while recording the lease income (lessor) or expense (lessee) in accordance with the original lease agreement. Under this approach, the periods in which rent forgiveness was provided would result in a net zero lease income (lessor) or expense (lessee) for the lease agreement in which the concession was provided.
- Treatment of the rent forgiveness as a lease modification, which requires the original lease agreement to be re-amortized with the lease forgiveness amount to be applied over the remaining life of the lease. Under this approach, the lease payment forgiveness amount would be amortized across the remaining term of the lease under the original agreement, lowering the lease income (lessor) or expense (lessee) in the remaining periods of the lease term on a straight-line amortization basis.
Following the accounting elections identified above, this presents the entity with the option to either recognize an offsetting lease payment in accordance with the original lease agreement to present a net zero impact within the profit and loss or to re-amortize the lease agreement with the lease forgiveness amount to be applied over the remaining life of the lease. This election to re-amortize the lease agreement would occur on each lease agreement in which this election is applied.
Overall, the two elections identified by the FASB present the entity with the decision to either immediately recognize the lease payment forgiveness within the statement of profit and loss or ratably over the remaining term of the original lease agreement.
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Treatment of Lease Concessions Across Lease Agreements
Under the FASB supplemental guidance for the lease concessions resulting in lease payment deferrals and lease payment forgiveness, entities are to apply the elections to leases with similar characteristics and circumstances.
Therefore, while the FASB allows for flexibility in the treatment of the accounting elections, entities should be mindful of the circumstances of the pandemic and their effect on the individual lease assets as well as the class of lease assets in the aggregate. Accordingly, entities retain the ability to apply reasonable judgement in the application of the accounting elections across the lease assets based upon the individual circumstances and effects of the pandemic on the lease asset and their ability to be utilized in operations.
Implementation of Lease Concessions
Upon implementation of the allowable accounting elections for lease concessions relating to the deferral of rent payments as well as lease payment forgiveness, the FASB requires entities to provide additional disclosures over the concessions granted.
These disclosures are to stipulate the concessions granted (lessors) or received (lessees) and their related accounting effects to provide a clear understanding of the lease concessions related to the pandemic. These expanded disclosures will assist the users of the financials to understand the accounting elections taken, and their related effects on the financial statements of the entity, related to the lease concessions granted (lessor) or received (lessee) due to the economic hardships of the pandemic.
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