The accounting for lease concessions in a COVID-19 environment can be complex. Crowe can help you gain clarity.
The COVID-19 pandemic has led to an increase in the number of contract modifications organizations are executing. One common form of modification occurring in the current environment is lease concessions. For example, earlier this year, many lessors were granting lessees limited rent abatements (partial or total forgiveness of certain rent payments) or temporary deferrals of rent payments given the business disruptions and other challenges caused by the pandemic.
To ease the burden on organizations of having to analyze a potentially significant number of lease concessions under the relevant lease modification guidance, in April 2020 the Financial Accounting Standards Board (FASB) released a staff Q&A document to “respond to some frequently asked questions about accounting for lease concessions related to the effects of the COVID-19 pandemic.” Among other things, the FASB staff Q&A document grants organizations relief from having to individually analyze each lease concession to determine whether the concession was granted in accordance with the terms of the lease contract or is a modification to the contract. Specifically, organizations can elect to either treat the lease concession as if it were granted under the terms of the contract or as a modification without undertaking a thorough review of the enforceable rights and obligations of each affected lease contract (referred to hereafter as the “FASB staff practical expedient”).
To help you better understand some of the implications of applying the FASB staff practical expedient, we answer some frequently asked questions about the FASB staff Q&A document.
Who is eligible to apply the FASB staff practical expedient?
While not explicitly stated in the staff Q&A document, we believe the FASB staff practical expedient is available to both lessors and lessees and applies to all lease classification types – operating, finance, sales-type, and direct finance.
Why would I want to apply the FASB staff practical expedient?
If an entity chooses not to apply the FASB staff practical expedient, then it would be required to individually analyze each lease concession to determine if the concession was granted in accordance with the enforceable terms of the contract (for example, in accordance with a force majeure provision or similar clause) or not. This determination is not always clear and, consequently, it might require involvement of legal counsel.
Furthermore, if an entity concludes that a lease concession is a modification, then it would be required to apply the modification guidance under the applicable lease standard – either Topic 840 or Topic 842 – which likely would involve (among other things) the following:
- Remeasuring and reallocating contract consideration to the various lease and nonlease components in the arrangement.
- Reassessing lease classification using updated inputs (for example, the fair value of the leased asset and the incremental borrowing rate).
- Remeasuring the lease liability.
Depending on the number of lease concessions an entity enters into, the cost, complexity, and effort of performing the above requirements could be significant.
At a minimum, an entity that elects to apply the FASB staff practical expedient would not need to individually assess each lease concession to determine whether it should be accounted for as a modification or not. In addition, if an entity chooses to treat a lease concession as part of the terms of the contract, it would also be able to bypass having to apply modification accounting to the concession.
Must I apply the FASB practical expedient to all my COVID-19-related concessions?
No. The election to apply the FASB staff practical expedient is neither a lease-by-lease election nor an entitywide election. Rather, the staff Q&A document indicates that the election should be applied to all concessions with similar characteristics and in similar circumstances.
For example, an organization might conclude that it will treat all concessions that involve rent deferrals a certain way and all concessions that involve rent abatements a different way.
How do I determine if my lease concession is eligible for the FASB staff practical expedient?
The FASB staff practical expedient is applicable to all lease concessions that meet both of the following conditions:
- The concession is related to the effects of the COVID-19 pandemic.
- The concession does not result in a substantial increase in the rights of the lessor or the obligations of the lessee (for example, the total payments required by the modified contract are substantially the same as or less than total payments required by the original contract).
The FASB staff Q&A document does not provide significant interpretive guidance on these two conditions. However, it does note the “FASB staff expects that reasonable judgment will be exercised in making those determinations.”
Refer to the following question and answer for some of our interpretive views on the second condition.
What are some things I should consider when determining whether a lease concession results in total payments that are “substantially the same as or less than” the total payments required under the original terms of the contract?
The FASB staff practical expedient only applies to lease concessions that, among other things, result in total payments that are substantially the same as or less than the total payments required under the original contract. We believe “substantially the same” means a change in total payments of no more than 10%.
However, among other things, the FASB staff Q&A document does not state whether the analysis of total payments should be performed using either:
- Discounted cash flows or undiscounted cash flows
- Total payments over the entire lease term or total payments over the remaining lease term as of the date the lease concession was granted
Given that the staff Q&A document does not express a view on either of these matters, we believe an entity can perform either a discounted or undiscounted cash flow analysis using either the entire lease term or the remaining lease term. In other words, an entity should establish an accounting policy and consistently apply that policy to all lease concessions.
Another interpretive matter not addressed in the FASB staff Q&A document is whether consecutive concessions provided by a lessor to a lessee should be combined or analyzed separately. We believe an entity should look to the contract combination guidance in ASC 842-10-25-19 to make that determination. Significant management judgment may be required.
How do I account for lease concessions under the FASB staff’s practical expedient?
The FASB staff practical expedient allows entities to treat a lease concession as either part of the original terms of the contract or as a modification. If an entity elects to treat a concession as a modification, it would apply the relevant modification guidance under either Topic 840 or Topic 842.
On the other hand, if an entity elects to treat a concession as part of the original terms of the contract, it will need to apply judgment to determine an appropriate accounting policy for the concession. This is because the staff Q&A document does not prescribe a specific accounting treatment for lease concessions that are part of the original terms of the contract.
We believe the following approaches (not all-inclusive) may be acceptable depending on the type of concession being granted:
- Account for the concession as a variable lease payment. Under this approach, a lessee and lessor would account for rent abatement or rent deferral as a negative lease payment in the affected period, with any future repayment treated as a positive variable lease payment.
- Account for the concession as a resolution of a contingency (lessees only). Under this approach, a lessee would remeasure the lease liability as of the date of the concession based on the revised terms but would not reassess lease classification or update the discount rate. Any change to the lease liability would generally be recorded as an adjustment to the right-of-use asset.
- Account for the concession using a payables or receivables approach (rent deferrals only). Under this approach, both the lessee’s and lessor’s accounting for the lease would generally remain unchanged. However, a lessee (lessor) would increase its rent payable (receivable) account in periods in which payments are deferred and reduce its rent payable (receivable) account in future periods in which payments are ultimately made.
An entity should be consistent in how it accounts for similar lease concessions.
Do short payments qualify as a lease concession?
A “short payment” refers to the situation when a lessee unilaterally decides to not make a rent payment (or a full-rent payment) when otherwise due and payable. Though the lessee might be seeking relief from the lessor, short payments do not qualify as concessions to which the FASB staff practical expedient can be applied. Generally speaking, a lessee’s and lessor’s accounting for a lease contract should not change until the two parties have mutually agreed to changes in the terms of the contract. If the lessor ultimately accepts the short payment as full satisfaction for the related period(s) under the lease, then the practical expedient can be applied (assuming all other scoping criteria have been met).
What are some of the other financial reporting implications of electing to apply the FASB staff practical expedient?
If an entity chooses to apply the FASB staff practical expedient, it should disclose that fact along with both of the following:
- The terms of material concessions received (lessees) or granted (lessors)
- The accounting effects of the concessions to enable users to understand the nature and financial effect of the lease concessions