What are rent concessions?
Rent concessions are discounts, incentives, or other benefits provided by landlords to tenants. Landlords sometimes offer rent concessions to entice tenants to sign a new lease — or concessions may come up as part of lease negotiations. For instance, due to the impact COVID-19 had on businesses, many companies asked for concessions from their landlords in 2020 to ease costs related to real estate leases.
Under the lease accounting standards, any lease concession must be captured and accounted for on the balance sheet. While FASB and IFRS offer some flexibility in how to account for rent concessions, including rent abatements and deferrals, their unpredictable nature presents an ongoing challenge to lease accounting and compliance.
In this blog, we identify some common lease concessions and offer some helpful advice for handling them.
Type of rent concessions
Common types of rent concessions include:
- Abatements: Temporary rent waivers
- Deferrals: Postponed payments
- Short pays: Reduced payments for a period
- Impairments: Reduction in the lease’s value
- Early terminations: Allowing tenants to exit the lease early
Each type serves different purposes and can have a large impact on lease accounting and financial reporting under ASC 842.
Rent abatement
Rent abatement is a temporary decrease in the rental rate. When this option is elected, a landlord and tenant often negotiate a short-term abatement so that the payment reduction applies for a defined period, such as three or six months.
Therefore, a rent abatement typically changes the total amount of rent the tenant will pay over the full lease term.
Rent deferral
Rent deferral is a temporary reduction in rent that requires repayment of the balance later. This does not change the total amount of the payments the tenant will make but defers the timing of the payments.
Landlords may be more willing to work with tenants on a rent deferral than an abatement. However, they may agree to an abatement in exchange for some trade-off of rights and obligations, such as extending the lease term.
Short payments
A short payment, or short pay, is a partial lease payment. In this situation, the landlord may agree to accept less than the full payment amount for a set period, with the tenant expected to repay the remaining balance later.
Because the full lease payment has not been made, the unpaid amount may create an outstanding liability. Short payments can also create accounting and compliance challenges if the repayment terms are not clearly documented. Depending on the lease agreement, a short payment may be treated as late or may be subject to late fees unless both parties agree to different terms in writing.
Lease impairment
An impairment is when the current value of a leased asset (such as real estate, vehicles, or equipment) is lower than the balance due according to the lease. The result is the impairment of the ROU asset, which may require a different amortization calculation for operating leases.
From the lease holder’s point of view, assets may be impaired if the demand for those assets decreases or if rental rates drop significantly.
Early terminations
An early termination is when a tenant decides to end a lease before its expiration date. But unless a lease includes an early termination clause, companies face serious repercussions when they terminate a commercial lease early.
For instance, if a company decides to terminate a lease early, it may still have to pay some or all the rent due through the end of the lease term. In addition, the landlord might sue for monetary damages.
Even if a lease does include an early termination clause, it generally imposes a termination fee and may include some restrictions or other reimbursements to the landlord.
What are best practices for handling rent concessions?
Rent concessions can affect lease accounting, reporting, and compliance, so they should be handled with a clear and consistent process. Whether the concession involves an abatement, deferral, short payment, or another lease change, companies should document the terms carefully and evaluate the accounting impact before making changes to their lease records.
Treat similar lease concessions consistently
When possible, similar lease concessions should be treated in a consistent way. This helps simplify decision-making and creates a clearer audit trail.
However, the proper accounting treatment depends on the nature of the concession, the lease terms, and the applicable accounting guidance. Some concessions may be treated as variable payments, while others may need to be accounted for as lease modifications. If a concession changes the rights or obligations of the landlord or tenant in a meaningful way, it may require additional accounting review.
Document the accounting treatment
Each rent concession should be supported by clear documentation. This includes the type of concession, the reason it was granted, the affected lease period, and whether the concession changes the total lease payments, payment timing, lease term, or other lease obligations.
Companies should also document whether the concession is being treated as a variable payment, lease modification, or another applicable accounting treatment. This helps support internal reporting, audit review, and financial statement disclosures.
Plan ahead for deferred lease payments
Lease deferrals can create added complexity because they do not always reduce the total amount owed. Instead, they often move payments into a future period.
Before accepting or recording a rent deferral, companies should understand how the repayment schedule will affect future cash flow, lease liabilities, and rent expense. A deferral may provide short-term relief, but it can also increase payment obligations in later periods.
Review rent abatements carefully
A rent abatement reduces or waives rent for a specific period. Depending on the lease terms and the reason for the abatement, it may need to be evaluated as a lease modification or accounted for through another applicable treatment.
If the abatement changes the total consideration in the lease, the company may need to reassess the lease liability, right-of-use asset, and related expense recognition. Because the accounting impact can vary, lease abatements should be reviewed carefully before updates are made to the lease accounting schedule.
Provide clear lease accounting disclosures
Disclosures are important when rent concessions affect lease accounting. Clear disclosures help auditors, investors, and other stakeholders understand how concessions were handled and how they affected the financial statements.
Disclosures may include:
- The types of rent concessions received, such as abatements, deferrals, short payments, or early terminations
- Whether similar leases were treated consistently
- The accounting treatment applied to the concessions
- Any practical expedients or policy elections used, if applicable
- The financial statement impact of the concessions
Financial statement impact of lease abatement under ASC 842
The financial statement impact of lease abatement under ASC 842 can vary depending on the specific terms of the lease and the amount of the lease abatement. However, in general, lease abatement can have the following financial statement impacts:
- Reduced rent expense: If the lease abatement is treated as a reduction in rent expense, it will reduce the rent expense on the income statement. This can improve the company’s gross profit margin and net income.
- Increased right-of-use asset: If the lease abatement is treated as a lease modification, it will increase the right-of-use asset on the balance sheet. This can have a negative impact on the company’s debt-to-equity ratio and financial leverage.
- Reduced lease liability: If the lease abatement is treated as a beneficial lease modification, it will reduce the lease liability on the balance sheet. This can have a positive impact on the company’s debt-to-equity ratio and financial leverage.
Use lease management software to track concessions
Managing rent concessions like abatements, deferrals, and early terminations can make lease accounting more complex. Ensuring compliance, accuracy, and proper reporting of rent concessions is critical for maintaining the financial health of your business.
A modern lease management software like Visual Lease’s can simplify the process by automating the tracking and reporting of rent concessions, providing real-time insights, and ensuring compliance with lease accounting standards. Take control of your lease management and streamline your rent concession processes with Visual Lease today.
