The first half of 2020 will have been dominated by the effects of the worldwide pandemic in every sphere – economic, ecological, governmental, agricultural, industrial, medical, financial and personal.
From an accounting standpoint, these effects have been very keenly felt in many sectors with features such as lay-offs, reduced demand, reduced revenue and reduced value in the business.
With increased financial pressure placed upon organisations globally and as a result of the pandemic, many lessees have been seeking rent concessions from lessors. The rent concessions often come in various forms such as rent waivers, one-off rent reductions, or lease payment deferrals.
This article seeks to highlight the options and guidance offered by FASB and emphasize the benefits that lessees can achieve by utilizing a proven and robust lease accounting solution to be able to accurately account for their leases in response to the recently announced COVID-19 related amendments.
The Accounting Implications
The pandemic has seen the forced closure of restaurants, cinemas, shops, theatres and other premises. Though temporary these measures have usually been as a result of government action. Where there is no government instruction to landlords to waive or delay rental collection then often, though not always, landlords have offered rental concessions voluntarily or as a result of requests from lessees unable to trade normally for the period of “lockdown”.
If a lessee makes a partial payment or no payment against a rental due but for the granting of a concession, then the lessee and lessor should both account for the rental as if it were in line with the original agreement, though the lessee is now under the original terms in arrears and possibly subject in accounting terms to a revised end date if the rental period is taken as a holiday – this status remains unless and until the lessor agrees to modify the contract by accepting the “short” payment.
In response to the pandemic and recognition of the unusual circumstances surrounding the granting and acceptance of rent concessions, FASB has issued guidance that permits a simplified approach to accounting for those COVID-19 related concessions. This guidance applies to all companies that are lessees and is effective immediately. Now finance managers will be reviewing previously accounted for assumptions surrounding options available under the leases they are committed to. However, generally, lease contracts will not cater for the granting of any concession due to incidences such as the declaration of a pandemic - similarly neither will accounting standards such as ASC 842, relatively new as it is.
Hence the recent guidance from FASB regarding ASC 842 and the updates to it – latest being 20-05. How, under ASC 842, any business accounts for rent concessions will depend on the enforceable rights and obligations of the contracted parties subject to the original lease agreement. As highlighted previously, concessions may arise from the laws of the jurisdiction governing the lease or any temporary change to those laws even if not written in the contract, or they may arise as a result of any changes agreed by the parties to the terms and conditions of that contract. Whatever is in the contract, the laws of the jurisdiction or any change in them can vary terms and conditions whether they are in the contract or not. If landlords are for a certain period, indeterminate or not, forced by a change in the law to forego foreclosure because of a failure to pay rent in full on time then the landlord is bound by that law.
Further to this, decisions that companies make during this uncertain time can affect how the non-cancellable period of a lease is redetermined. A lessee may be required to revise the lease term and remeasure the lease liability using a revised discount rate when there is a change in the non-cancellable period of a lease. Consideration will need to be given where the measurement of the lease liability as ascertained previously changes because -
- the lessee exercises an option not previously included;
- the lessee fails to exercise an option previously included;
- an event occurs that requires the exercise of an option not previously included; or
- an event contractually prohibits the exercising of an option previously included
FASB guidance under ASC 842 and subsequent updates (latest is 20-05)
- Where a rent concession under these circumstances is a function or option of the original lease contract such as a force majeure clause, the concession will generally be accounted for as a variable lease payment.
- Where there is no obligation on the lessor to grant a rent concession, the lessor’s agreement to grant one at the request or otherwise of the lessee must be accounted for as a lease modification.
- If specified criteria are met, lessees and lessors can elect to forgo the evaluation of the enforceable rights and obligations of the original lease contract that would otherwise be required by US GAAP when accounting for COVID-19 related rent concessions and instead account for those concessions as if they were required by the existing lease contract or alternatively as a lease modification.
Handling rental concessions and holidays is one thing, but businesses should also carefully consider whether as a result of COVID-19 related events there is now a need to review the impact on any renewal, termination or purchase options. This review should include assessing whether the impact will materially change the certainty or otherwise of any option being exercised. Finally, how those judgements and estimates with regard to lease terms and options were made need to be included in formal financial disclosures. Those disclosures should be expanded to include the accounting impact of any rent concessions taken as a result of the outbreak.
Businesses that have a sizeable lease portfolio by volume should further consider whether they have adequate lease accounting systems in place to manage through these times and beyond. Innervision's cloud-based lease accounting solution is being used by many global entities subject to FASB accounting standards to accurately and simply manage such variations to lease contracts both from an accounting and a portfolio management viewpoint.
New features have recently been added to the solution that accommodates both the FASB and IASB COVID-19 rent-related concessions. The system offers 3 accounting approaches for users to select from with in-built validations customised by the customer with associated disclosures.
If you are interested in finding out more about the new COVID-19 related functionality, request a call back from out of our lease accounting system specialist today.
If you would like to see it in action, request a demo below: