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 naturepresentsan ongoing challenge to lease accounting and compliance.
In this blog, we identify some common lease concessions and offer some helpful advice for handling them.
What are some common rent concessions?
Some 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), and 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.
What is rent abatement?
Rent abatementis 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 deferralis 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
Ashort payis apartial payment. A landlord might agree to accept a short pay until the tenant can repay the remaining amount of the lease payments.
A short or partial payment results in a liability.In addition, since a short pay is considered a late payment (even if it is paid on time), it may be subject to late fees unless both parties agree otherwise.
Lease Impairment
Animpairmentis 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
Anearly terminationis 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.
(Learn more aboutthe costs of early terminations and other lease obligations.)
What are best practices for handling rent concessions?
Treat similar leases the same way.
Both FASB and IFRS allow you to choose to treat all rent concessions as either variable payments or a lease modification. This means you can treat similar leases the same way.
In other words, you do not have to comb through the terms of every contract to determine whether it meets the guidance for a lease modification or a variable payment treatment.This is apractical expedientthat saves time and simplifies decision-making.
There are two important things to keep in mind:
- You should disclose that you elected to treat similar leases the same way, as well as the treatment you chose to apply to lease concessions — variable payment vs. lease modification. (See more ondisclosuresbelow.)
- If a deferral,abatementor other concession requires you to exercise a renewal option that results in a significant change, you may have to account for the concession as a modification.
There is some flexibility in lease abatement accounting.
Both FASB and IASB allow you to treat rent abatements as either existing lease obligations or as negotiated modifications to the lease terms. However, if the lease concession materially increases the landlord’s rights or the tenant’s obligations, it must be treated as a modification.
- If an abatement is considered avariable lease payment, no remeasurement is required and the abatement flows through to any disclosure reporting.
- If an abatement is considered anegotiated modification, a remeasurement should be run when the abatement term is agreed on and continue through the rest of the lease term.
For example, a large manufacturing company that reports under IFRS 16 handled a three-month rent abatement by reducing its short-term and long-term liabilities for those months while still showing activity from a balancing perspective. From a P&L perspective, the company showed the benefit of no rent expense for those three months.
Think ahead when planning for deferred lease payments.
With a lease deferral, your organization needs to considera number ofvariables and make decisions based on how it will impact your company’s P&L statement.
- If you choose to report a deferral as a variable expense, you will book the benefit of the lease concession today and the expense of the repayment at a future point in time.
- If you choose to treat the deferral as a lease modification, the immediate impact will be less, but the expense will be spread out and extend into future periods.
For some companies, it might make sense to push the expense of deferred rent off to next year rather than inflate payments for FY2020. For instance, suppose a company that received a 3-month rent deferral in 2020 wants to defer payment as far into 2021 as possible. If the company treated the deferral as a variable payment, it would have to recognize the rent expense in 2020 even if the payments are made in 2021.
Be sure to provide disclosures.
As with much of lease accounting under strict standards, there are a lot of decisions to make. Providinglease accounting disclosureswill help auditors and understand your financial statements, including:
- Any abatements, deferrals or other lease concessions received
- Whether all leases (or similar leases) are treated the same way
- Which practical expedients werechosen
By providing disclosures, you can clarify decisionsyou’vemade and demonstrate that you have treated lease concessions consistently.
Accounting for Rent Abatement Under ASC 842
Under ASC 842, lease abatement is treated as a lease modification. Lease modifications are changes to the terms of a lease that are made after the lease has been entered into. Lease modifications can be either beneficial or onerous to the lessee.
If a lease abatement is beneficial to the lessee, it is recognized as a reduction in the lease liability over the lease term. If a lease abatement is onerous to the lessee, it is recognized as a lease liability over the lease term.
For example:
If a company receives a rent abatement for the first 6 months of a 10-year lease, the rent abatement is treated as a beneficial lease modification. The lease liability is reduced by $300,000 (6 months * $50,000 per month). The rent expense is reduced by $50,000 per month over the remaining 9 years of the lease.
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.
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.
