FASB Provides Lease Concessions Guidance Due to COVID-19
As companies adjust to their new normal under COVID-19 and most put revenue recognition accounting implementation in their rearview mirror, lease accounting arises once again as a hot topic. Businesses have either already implemented the largest overhaul in lease accounting in decades, Accounting Standards Codification (ASC) Topic 842, or they have taken advantage of effective date delays and continue to operate under ASC Topic 840 until calendar year 2022. Regardless of which side businesses are on, a new challenge has presented itself – how do we account for lease concessions offered by landlords providing COVID-19 relief? As a result, the Financial Accounting Standards Board (FASB) recently issued a Q&A document to guide stakeholders through the application of lease accounting related to concessions.
What Is Lease Modification Accounting and Do We Need to Apply It?
Subsequent changes to lease payments that are not stipulated in the original lease contract are most often accounted for as lease modifications under ASC Topic 840 or ASC Topic 842. Certain lease contracts may contain enforceable rights and obligations for concessions, which preclude those contracts from the need to apply lease modification guidance. However, before the release of the FASB’s recent Q&A forum, absent the presence of these enforceable rights and obligations, lease concessions would have required lease modification guidance to be followed.
The FASB listened to a cross-section of stakeholders raising concern that the unprecedented circumstances of the pandemic, coupled with the volume and speed with which lease concessions have been issued, warrant a policy election to accounting for lease concessions. Consequently, for concessions directly related to effects of the COVID-19 pandemic, an entity may elect to treat leases as if enforceable rights and obligations regarding concessions exist in each contract; thus, they can “opt out” of the lease modification guidance. This election is available for concessions that do not result in a substantial increase in the rights of the lessor or the obligations of the lessee (i.e., they do not increase the amounts owed to the lessor). If the election is made, entities would still need to apply it to all leases with similar characteristics and in similar circumstances.
Here we focus on the application under ASC Topic 840, as most privately held businesses have yet to adopt ASC Topic 842. Additionally, the FASB is currently discussing additional amendments to ASC Topic 842 as it relates to lease concessions.
Lessees: What If We Elect Out of the Lease Modification Guidance?
Lessees – Operating Leases
Concessions will certainly vary in form, but payment forgiveness and deferral of payments are expected to be the most common types of concessions granted. If a rent deferral is provided, there are two ways to account for it. The first option allows the lessee to increase rent payable and continue to recognize expense during the incurred period. This would be the most conservative approach for a lessee. Alternatively, the lessee could account for a payment deferral as contingent rent, whereby expense would effectively be recognized when the payment is made. Normal, straight-line expense in the deferral month would be recorded, along with a negative contingent expense in the amount deferred; the positive contingent expense for the deferral would be recorded when payment is remitted.
When rent is forgiven, lessees would treat this similarly to contingent rent mentioned above, whereby a negative contingent rent expense would be recorded for the forgiveness to reduce the normal monthly straight-line rent expense recognized. Alternatively, the forgiven amount could be spread over the remaining lease term if the modification guidance is used.
Lessees – Capital Leases
When the leased asset is capitalized by the company with a related capital lease liability recorded, a rent deferral (with no added interest) would not require any additional entries to be recorded. Instead of remitting cash, a payable would be created for the deferred payments. Alternatively, a company could record the deferral as a contingent expense, as discussed above (record the benefit when deferred and the extra expense when paid).
If a lessee experiences forgiven rent related to an asset under capital lease, the company would reduce the related lease liability and record negative expense related to the lease payment forgiven.
Lessors: What If We Elect Out of the Lease Modification Guidance?
Once again, with rent deferrals, two options arise. Lessors of operating leases can increase their lease receivable and recognize income as they normally would. Alternatively, in a more conservative approach, the lessor can elect to account for the lease receivable as contingent rent (similarly to lessees) and record it when received.
When lessors of operating leases forgive rent, they would decrease any lease receivable or lease income previously recognized by the amount forgiven. This could also be done ratably over the remainder of the lease term.
Companies must disclose in published financial statements the material concessions granted (lessors) or received (lessees) and the accounting treatment used. Companies still need to follow all other disclosure requirements of ASC Topic 840 or ASC Topic 842, as applicable.
The application of accounting guidance to lease contract changes, whether COVID-19-related or otherwise, requires a careful consideration of all the facts and circumstances. While the FASB’s recent Q&A was intended to provide accounting relief to those receiving lease concessions, many questions remain related to the implementation of this option. If you have questions, please reach out to your KSM advisor or complete this form.
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