As the uncertainty surrounding the impacts of the COVID-19 pandemic continues to grow, the Financial Accounting Standards Board (FASB) staff have provided some relief guidance pertaining to lease concessions for lessors and lessees under the standard Topic 840 and Topic 842 for leases. More and more companies are being impacted by the disruption and many landlords have been asked to provide lease concessions to their tenants.
Lease Modification Requirements
Under traditional Generally Accepted Accounting Principles (GAAP), a concession or other change to a lease from the original contract could be considered a lease modification requiring accounting under the lease modification guidance if rights and obligations related to the concession or other change are not stipulated in the lease contract. A lease modification would require the lease to be reevaluated as if a new contract is created that could result in changes to straight-line calculations, lease liabilities, and expenses. The original guidance was drafted to address any routine changes to leases, but it did not anticipate the volume of lease concessions that could result from a pandemic, such as COVID-19.
The volume of requests from tenants for rent deferrals and other concessions has grown considerably over the last month and has proven to be overwhelming to both landlords and tenants to determine if rights and obligations related to the concessions are stipulated in the lease contract. The new relief guidance is meant to offer an alternative to analyzing each individual lease contract to determine if rights and obligations exist for lease concessions.
Guidance Options for Lease Portfolios
As some lessors and lessees have a portfolio of leases, the time to review each lease would be a challenge. If certain criteria are met, the FASB issued guidance allows lessors and lessees the option to elect to apply or not apply the contract modification guidance in Topic 840 and Topic 842 for lease concessions related to COVID-19. This new guidance means that an entity can assume that the granting of those concessions existed in the original lease contract, regardless of whether explicitly stated.
The FASB has offered several models for accounting for lease deferrals under the above election. These include adjusting any straight-line rent calculations to reflect the rent concessions, recording an accrual for an asset or liability strictly for COVID-19 concessions, and reporting the concessions as a variable lease payment. All of these should be considered to determine the model that best suits the entity. The model is to be applied consistently to similar leases, but also the FASB staff guidance is to be applied consistently to similar leases. For example, the decision to apply or not apply modification accounting.
Prior to applying the election and choosing a model to account for the concessions, items to consider for both lessors and lessees are:
- Do the concessions extend the term of the lease?
- Do the concessions result in a change to the total amount paid under the lease contract?
- Are the concessions a deferral or a forgiveness of rent?
- Do the concessions increase the obligations of the lessee or the enforceable rights of the lessor?
If material, the model chosen and the impact on the entity should be disclosed within the financial statements, if applicable, and should be discussed with your accounting professionals.
Certain software used by lessors have available models for reporting and tracking various transactions for these concessions. New accounts are created that are specifically utilized to track the concessions granted to the lessee. If your entity uses leasing software, you might consider reaching out to the developer to determine if there are options or models for your current software that can assist with the tracking of the concession transactions.
Please refer to the updated leasing guidance and a copy of the Q and A from the FASB provided on their website.
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The information and advice we are providing for this matter relates to COVID-19 legislative relief measures. Because legislative efforts are still ongoing, we expect that there may be additional guidance and clarification from regulators that could modify some of the advice and information provided to you, after the conclusion of our engagement. We, therefore, make no warranties, expressed or implied, on the services provided hereunder.