With all the business closures and cutbacks due to the COVID-19 pandemic, a lot of companies are worried about not only managing their lease expenses now, but also accounting for changes to payments and other lease obligations later.
As the COVID-19 emergency continues, more companies are faced with making critical decisions on lease issues, which in turn have an impact on lease accounting.
How will lease concessions and other changes that occur in the wake of the COVID-19 crisis affect your lease accounting?
How to Handle Lease Changes Related to COVID-19
While there are not any additional lease accounting processes or rules to learn for handling concessions due to circumstances surrounding COVID-19, you may elect the method of selecting practical expedients, instead of performing a lease–by–lease analysis of the legal language. This change currently applies to both FASB guidelines (whether 842 or 840) and IASB, but only for lessee schedules. Other lease accounting issues will continue to be guided by the specific terms of your lease contracts and your lease accounting standards (i.e. ASC 842, IFRS 16, GASB 87).
While you should always consult with your accounting advisory partner regarding your specific situation, the following guidelines can help as you consider the different concessions that may apply to your lease accounting during and after COVID-19:
The COVID-19 pandemic is causing companies to ask how to account for rent abatements. The FASB and IASB have provided the ability to elect to treat rent abatements as either existing lease obligations, or as negotiated amendments to the terms. However, there are limitations on this ability to choose. For example, modifications which materially increase the lessor’s rights or the lessee’s obligations must be treated as modifications.
If a company elects to not take the expedient of not determining if the lessor is obligated to provide a rent concession, or if the lease is not eligible for such election, the treatment will be dictated by the terms of the lease:
- If the landlord is obligated, the concession is considered a variable lease payment. No remeasurement is required, and the abatement will flow through to any disclosure reporting.
- If the landlord is not obligated, the concession is considered a negotiated modification. A remeasurement should be run when the abatement term is agreed on and continue through the lease term.
- In the event there is not an agreement to abate rent, this is considered a short payment. The payment is recorded in Visual Lease as if made, but as in the normal course of events, the cash transaction books to Accounts Payable. Therefore, while the Ending Liability is reduced on schedule, it is replaced by an Accounts Payable liability until the payment is made.
COVID-19 presents such an unforeseen and disruptive impact upon operations, therefore, many companies are electing to keep related costs and abatements distinct from normal operating expenses. As a result, we suggest creating distinct financial categories in this situation.
Accounting for Changing Discount Rates
Lower interest rates in response to COVID-19 may affect the Incremental Borrowing Rate (IBR) that lessees typically use as their “discount rate” for lease accounting. The IBR may also be affected if borrowing costs change — for example, because of a declining credit rating.
A lower interest rate increases the calculated amount of a lessee’s right-of-use (ROU) assets and lease liabilities. This in turn affects balance sheets when lessees enter new leases, remeasure existing leases, or transition to new lease accounting guidance.
With more people working from home, some businesses may invoke a lease clause or negotiate a lease modification to reduce their square footage and the related costs.
Referring to your lease accounting guidance can help you identify what options you may have for recording a partial termination or other modification that reduces the scope of a lease. For example, under ASC 842, you have the choice of reducing the ROU asset proportionate to either the reduction in the lease liability or the reduction in the leased space.
In an economic downturn, leased assets such as property, plants and equipment may be valued below their current balance. The result is the impairment of ROU assets, which may require a different amortization calculation for operating leases.
From the lease holder’s/lessor’s point of view, some assets held for lease may be impaired if demand for those assets decreases or if rental rates drop significantly.
For either party, a lease accounting software solution with automated impairment processing helps to simplify the complex process of recording these types of lease impairments.
Handle It All with Good Communication, and Intuitive Software
In any still-evolving situation like the COVID-19 pandemic, it is always a good idea to consult with your legal counsel and accounting advisory partner as needed to make sure you understand all your rights, obligations and expenses regarding your leases.
Maintaining good communication among all parties in a lease is extremely important to help you from avoiding potential high-risk misunderstandings and mitigate conflict. For example, a landlord may misinterpret a tenant’s need to shutter the doors for the short term as abandonment. Or, a tenant could have difficulty getting a concession for unused office space if the business closure is not documented and the landlord is not notified according to the lease terms.
Additionally, taking advantage of tracking your leases clauses and financials within a reliable lease accounting and administration software, such as Visual Lease, is incredibly helpful to save your organization significant time and money during and after COVID-19. For more information to see how Visual Lease can help your business evaluate your leases as it relates to COVID-19, visit here or reach out to us today to learn more about our COVID-19 lease impact service.