Organizations that experience challenges related to COVID-19 may need to renegotiate their lease contracts. There’s an election available related to accounting for lease forbearance.
Key insights
- As a result of the COVID-19 pandemic, some organizations may find it difficult to make lease payments.
- Many lessors are providing lease concessions, including payment forgiveness and deferral of payments. In some cases, government actions are requiring forbearance.
- There’s guidance available for lease concessions related to the effects of the COVID-19 pandemic and an election that may simplify the accounting.
In 2020, the world changed due to the COVID-19 pandemic. Governmental and societal restrictions followed, which caused businesses nationwide to close or experience significantly reduced traffic. Unfortunately, the pandemic and resulting business downturn also forced many lessors and lessees to the negotiating table, resulting in lease concessions. Read on to learn how to account for these concessions.
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FASB weighs in an accounting policy election
In their May board meeting, the Financial Accounting Standards Board (FASB) recognized that accounting for lease concessions related to the pandemic would be a severe pain point for many businesses.
Historically, if concessions were granted, both parties to the lease would need to perform a complex and costly legal analysis to determine if the concession represented a lease modification or was a result of a contractual or legal right (enforceable right) of the lessee. Generally, if the concession was granted due to enforceable rights, the lease modification framework would not apply.
Fortunately, FASB has provided relief for parties involved in a forbearance arrangement, in the form of an accounting policy election. Organizations may forgo performing an analysis on each lease. Instead, organizations can elect to account for lease concessions as though the enforceable rights and obligations for those concessions existed, regardless of whether those enforceable rights and obligations for the concessions are explicitly set forth in the contract.
FASB observed that electing out of the lease modification accounting is only available when the total cash flows resulting from the modification are “substantially the same or less” than the cash flows in the original contract. However, “substantially the same or less” was not defined and you’ll need to use reasonable judgement.
Note: CLA is a premier resource for private businesses and owners, who in most cases have not implemented ASC 842, so this analysis will focus strictly on the accounting requirements under ASC 840.
Lease concession accounting implications
FASB acknowledges that there will be multiple ways to account for deferrals, but has not indicated a preference for one method over the others. Two of those methods are as follows:
- Account for the concessions relating to deferrals as if no changes to the lease contract were made. Under that accounting, a lessor would increase its lease receivable, as receivables accrue. Similarly, a lessee would increase its payable as the payables accrue. In its income statement, a lessor/lessee would continue to recognize income/expense during the deferral period.
- Account for the deferred payments as variable lease payments.
Below are examples of the lessor accounting for both a rent abatement and deferral.
Lessor accounting for rent abatement
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Lessor accounting for rent deferral
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Regardless of the election made, you’ll need to include disclosures surrounding material changes in the lease arrangements resulting from concessions.
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