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How to handle lease concessions: deferrals, abatements and other modifications

By January 28, 2021Lease Accounting

 

Lease concessions are discounts, incentives, or other benefits provided by landlords to tenants. Landlords sometimes offer lease 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 new 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 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. 

What are some common lease concessions?

Common types of lease concessions include abatements, deferralsshort paysimpairments and early terminations. 

What is a lease abatement? 

An 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. 

What is a lease deferral? 

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.

What are short payments? 

short pay is a partial 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. 

What is a 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.

What are 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. 

(Learn more about the costs of early terminations and other lease obligations.)

What are best practices for handling lease concessions? 

Treat similar leases the same way. 

Both FASB and IASB allow you to choose to treat all lease concessions as either variable payments or a lease modification. This means you can treat similar leases the same way. (Read the FASB Q&A on lease concessions here.)  

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 a practical expedient that 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 on disclosures below.) 
  • If a deferral, abatement or 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 a variable lease payment, no remeasurement is required and the abatement flows through to any disclosure reporting.  
  • If an abatement is considered a negotiated 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 consider a number of variables 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 the new standards, there are a lot of decisions to make. Providing lease accounting disclosures will 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 were chosen 

By providing disclosures, you can clarify decisions you’ve made and demonstrate that you have treated lease concessions consistently. 

Look ahead for ongoing compliance 

During a recent Visual Lease webinar, a quick survey of the attendees showed roughly half received some sort of rent concession in 2020. These and any other companies that receive lease concessions must account for and disclose those concessions if they are going to maintain FASB and IFRS compliance.  

Even private companies that have not yet adopted the new standards and must transition to ASC 842 by December 15, 2021, will need to include lease concessions in their lease accounting and disclosures. 

As you plan for lease accounting, keep these key takeaways in mind: 

  • You can take advantage of a practical expedient that allows you to treat similar lease concessions the same way. 
  • Look ahead to plan whether you should book expenses now or later, and choose a lease concession treatment accordingly (variable payment vs. lease modification). 
  • Provide disclosures to clarify your accounting decisions and demonstrate that you’ve applied lease treatment options consistently. 

To learn more about lease concessions from a panel of lease accounting experts, watch our on-demand webinar, Lease Concessions Masterclass 

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