The COVID-19 pandemic brought swift consequences for many industries, particularly for those in the retail and in the hospitality space. Foot traffic all but stopped as state, local, and federal governments recommended shelter-in-place ordinances. Sudden drops in demand may have left many businesses with difficult decisions about how to pay routine expenses, including how to make lease payments. Property owners then also faced difficult choices about what to do with the leases that could not be paid during the pandemic, and as a result, many made concessions to their arrangements, including lease payment forgiveness and payment deferral.
Lease concessions affect accounting for leases for both the organizations leasing property and equipment (lessees) and the organizations from whom they lease (lessors). In response to the sudden influx of concessions, the Financial Accounting Standards Board (FASB) recently issued a staff question and answer (Q&A) about how organizations can account for the effects of the COVID-19 pandemic on their leases. The Q&A serves as a first step in an overall effort by regulators to see how the pandemic may affect other changes to lease accounting. The major accounting update to ASC Topic 842 may be deferred for private companies and not-for-profit organizations as a result of the COVID-19 pandemic disruption (the comment period for the proposed deferral ends May 6).
Is a Lease Concession Always a Lease Modification?
Whether adjustments made to payment schedules or terms is accounted for as a lease modification depends on your contract. Some lease contracts explicitly or implicitly provide that situations outside of anyone’s control demand lease concessions, creating enforceable rights and obligations. If the contract comes with those enforceable rights and obligations and no changes are made to the contract, then it is not accounted for as a lease modification. This is true regardless of whether your organization has adopted the changes in ASC Topic 842 or follows the legacy guidance in ASC Topic 840. On the other hand, if lessors grant concessions that go beyond the contract’s enforceable rights and obligations, then those concessions would generally be treated as a lease modification.
How Do I Know if My Contract Contains Enforceable Rights and Obligations?
Analysis of contract language to determine if there are enforceable rights and obligations was never going to be easy, and the COVID-19 pandemic response environment further muddies the water. In addition to liquidity and economic stimulus relief measures, federal agencies are generally encouraging forbearance practices for organizations hard hit by the COVID-19 response measures. For lessees, these forbearance practices could include relief for payment obligations on leased assets whereas for lessors this could mean the lessor would temporarily not be obligated to make a leased asset available during the pandemic response.
Contract-by-contract analysis for enforceable rights and obligations might also be complicated because of the universal impact that the COVID-19 pandemic has made on business operations. Chances are, it’s more than one contract that would be affected by the COVID-19 pandemic, and the traditional accounting for whether the lease concession is accounted for as a modification was not designed for high-volume, economically uncertain situations like the one we are in now.
Are Regulators Offering Any COVID-19 Relief for Lease Concessions?
The FASB released the Q&A in part to acknowledge that the accounting rules, as written, are not realistic for the COVID-19 scenario. Even taking the volume issue aside, lessees and lessors would need to consider how the modification terms and conditions affect the economics of the lease for the remainder of the original lease’s term. The uncertainty over how long the impact over the COVID-19 pandemic relief measures will last make the economic analysis difficult if not impossible to execute.
In an effort to reduce the number of COVID-19 pandemic related changes that would traditionally be accounted for as lease modifications, the FASB is permitting entities to elect to treat concessions related to the pandemic as if enforceable rights and obligations for lease concessions existed in the contract, regardless of the contract’s actual language about enforceable rights and obligations.
There are a few conditions tied to the use of the election:
Modified Rights and Obligations
The concession cannot result in a substantial increase in the rights of the lessor or the obligations of the lessee, such as the lessee owing significantly more in payments to the lessor under the modified lease terms compared to the conditions in the original lease. Lessees and lessors should use reasonable judgment to determine whether the concession meets this condition.
Accounting for Payment Deferrals
Most often, the lease concessions will be related to payment deferrals. There are multiple ways to account for deferrals. The Q&A provides two examples for accounting for these payment deferrals:
- Accounting as if no change to the lease were made, which results in a lessor increasing its lease receivable, and lessee increasing its payable, and the income statement would still recognize the income or expense during the deferral period; or
- Accounting for the deferred lease payments as variable lease payments
Neither method is more preferable than the other.
Will There Still Be Situations Where Concessions Are Accounted for as Lease Modifications?
Yes, the election to treat COVID-19 pandemic related adjustments as a lease concession arising from enforceable rights and obligations rather than a modification is not mandatory. Organizations may choose to treat the concessions as lease modifications if they traditionally fit that bill. As with other accounting elections related to leases, however, if your organization chooses to take the lease concession election for one of its leases, it should also apply the election to its leases that have similar characteristics and circumstances.
How Does COVID-19 Affect My Lease Disclosures?
Both the guidance in ASC Topic 840 and ASC Topic 842 require disclosure for any concession made to a lease’s terms and conditions. Lessees and lessors should be prepared to disclose the details of the concessions to help their financial statement users understand the potential financial impact of COVID-19 on operations.
For More Information
To learn more about the impact of COVID-19 on financial reporting, please contact us.
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