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Friday, May 22, 2020

7 Lease Accounting Issues to Consider as a Consequence of COVID-19


The coronavirus pandemic is upending companies’ ability to pay rents or other lease obligations, as well as hampering ASC 842and IFRS 16 compliance. In turn, the pandemic may impact a company’s lease accounting in more ways than one. Here are some main issues for lessees to consider:


1. Rent Concessions

Your landlord could provide a rent concession in the form of deferred rent, rent forgiveness, or some other type of relief. Your accounting treatment of a concession depends on if you have an enforceable right to a concession.

If there is a force majeure (act of God) clause in the lease agreement, then it would often include pandemics such as COVID-19. If included, it would create a positively impacting variable lease payment due to the rent relief. The Financial Accounting Standards Board has clarified that a variable impact wouldn’t require remeasurement of right-of-use (ROU) assets and a lease liability.

No force majeure? This likely means a lease modification for the rent concessions, which would result in a remeasurement of the leases.


2. Discount Rates

As a result of COVID-19, regulators have dropped interest rates, which most likely will impact your incremental borrowing rate (IBR). As interest rates fall, so does your IBR. Discount rates won't impact existing leases but will affect new leases, remeasured leases and transition to the new lease accounting standard, if you are privately held. You should have a practicable, updatable methodology to determine IBR.


3. Fair Values

Not shockingly, commercial real estate has come down in fair value. Many lessees have requested a reevaluation because they do not feel valuations done at the beginning of 2020 are reasonable to use anymore. (Historically a 5-month-old valuation would still be used.)


4. Impairment

COVID-19 has impacted the business climate for many companies, and adverse changes could affect your long-lived assets or asset group. This could cause assets to be valued below their current balance, resulting in impaired ROU assets. ASC 842 requires a different amortization calculation of operating leases.

The overall process of recording lease-related impairments is complex; working with the right lease accounting software can assist with automating impairment processing. If implementing a new software was already part of your technology roadmap, you may want to consider moving forward.


5. Partial Terminations

After calculating the modified lease liability, you should adjust the ROU asset value by a proportionate amount. For example, if the lease liability decreases by 5% based on the new payment terms, you would calculate a 5% reduction in the ROU asset value. Any variance between the adjustment to the asset and the liability should be recorded in current period gain or loss.


6. Reassessments

Actions you take in response to the effects of the COVID-19 pandemic may lead to your reassessing the terms of a lease (or leases), including options to purchase. It is unlikely but possible that the pandemic will trigger a minimum lease payment or termination right.

The expected residual value of an underlying asset may be affected by the economic circumstances, requiring you to reassess the probable amount you will owe under a residual value guarantee.


7. Full Terminations or Abandonment

This is more likely to occur as companies are looking to maximize their efficiencies and use of space. An example would be possible space for overflow in heavy periods of demand – if your sales have suffered heavily, there may not be a practical use for the space any longer, and you may not be able to sublease it. This would prompt you to apply abandonment accounting (accelerated amortization of the ROU asset).


For the latest regulatory updates and more information on keeping your business running through disruption, visit our COVID-19 Resource Center.

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