A lease is a contract, or part of a contract, that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. ASC 842, Leases, provides the guidance for accounting for leases under U.S. GAAP.
In today’s blog post, we will look at accounting for a lease modification under ASC 842, as well as the FASB’s election available for lease concessions related to COVID-19.
Lease modification accounting addresses the subsequent accounting for leases for changes that happen after the commencement date. If you need a refresher on lease accounting or on the basic principles of accounting for leases, we have a set of 3 free lease microlearnings, a collection of lease eLearning modules, and an entire accounting topic page dedicated to leases that can help.
A subsequent change to a lease contract that was not stipulated in the original contract is generally accounted for as a lease modification.
A lease modification is defined in ASC 842 as:
A change to the terms and conditions of a contract that results in a change in the scope of or the consideration for a lease.
Examples of lease modifications include an extension of the lease term, an early termination of the lease, a change in the timing or amount of lease payments, or adding an additional right-of-use to the lease.
Due to the ongoing COVID-19 pandemic, it is expected that there will be an increase in lease concessions granted by lessors to lessees with the most common type being a deferral of lease payments.
The FASB has been monitoring the impact of the coronavirus. Understanding that stakeholders are experiencing disruption due to the COVID-19 pandemic, the FASB issued a Staff Q&A to respond to questions about accounting for lease concessions related to the effects of the pandemic. The FASB has provided relief in the form of an election, making it easier to account for COVID-19 related concessions should an entity decide to make the accounting election provided.
ASC 842 Accounting for a Lease Modification
If a lease is modified, the modified contract is evaluated to determine if it remains a lease or if the contract contains a lease. If a lease continues to exist, the modification can result in:
- A separate contract; or
- A change in the accounting for the existing lease (not a separate contract)
For a lessee, modification of a contract should be accounted for as a separate contract when the modification grants the lessee an additional right of use that was not included in the original lease, and the lease payments increase commensurate with the standalone price for the additional right of use, adjusted for the circumstances of the particular contract.
If both conditions are met, the result is two separate contracts – the unmodified original contract and a separate new contract.
If both the conditions indicated above are not met, the modified lease is not accounted for as a separate contract. The entity would need to reassess lease classification at the effective date of the lease modification, remeasure and reallocate the consideration in the contract, remeasure the lease liability, and adjust the ROU asset.
The lessor must also assess whether the lease modification results in a separate contract (or not a separate contract) based on the same criteria the lessee uses. If it is a separate contract, the entity would account for the separate contract with the lease the same way as other new leases under ASC 842.
If the modification does not result in a separate contract, the entity is required to reassess the classification of the lease as of the effective date of the modification using the modified terms. The accounting will depend on the classification of both the original lease and the modified lease.
Lease Concessions Related to the Effects of the COVID-19 Pandemic
The FASB received inquiries and comments from stakeholders highlighting the expectation that the number of concessions granted is expected to be substantial due to the impacts of COVID-19.
The FASB acknowledged that it may be challenging for entities to determine whether existing contracts provide enforceable rights and obligations for lease concessions, and if so, whether those concessions are consistent with the terms of the contract or are modifications.
In response, the FASB issued a Staff Q&A providing guidance to help reduce the challenges and complexity of accounting for leases in the wake of COVID-19. For COVID-19 related concessions, the FASB indicated it would be acceptable for an entity to make an election whereby they would not have to analyze each contract to determine whether enforceable rights and obligations for concessions exist in the contract and can elect to apply or not apply the lease modification guidance.
This election is available for concessions related to the effects of the COVID-19 pandemic that do not result in a substantial increase in the rights of the lessor or the obligations of the lessee.
To the view the full FASB’s Staff Q&A document, click here.
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