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Journal of Accountancy

Pandemic alters lease accounting landscapeThe coronavirus has led to a likely delay in the effective date of FASB’s new lease standard along with other possibleconsequences.

By Stephen G. Austin, CPA; Joel C. Colbourn, CPA; Ane Ohm, CPA; and Don Mitchell May 31, 2020

Image by Nikada/iStock

In addition to causing enormous disruption to health, safety, and the economy across the globe, the coronavirus pandemichas significantly altered the landscape for CPAs related to lease accounting.

The changes include a potential effective date delay of FASB's new lease accounting standard for certain entities, includingprivate companies; a monumental increase in the number of lease modifications requested by lessees and granted bylessors; and the need for disclosures related to a company's lease accounting decisions in the new environment. Here's acloser look at lease accounting amid the coronavirus pandemic.

LEASE CONCESSIONSShelter-in-place, stay-at-home, social distancing, self-quarantine, and other directives have caused significant disruptionsto business operations, with many businesses and industries being effectively shut down. This has resulted in record levelsof layoffs and unemployment claims, with a potential record number of bankruptcy filings expected over the next few

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months.

The federal government has taken several actions to provide relief from the devastating economic impact, includingenacting the Coronavirus Aid, Relief, and Economic Security (CARES) Act, P.L. 116-136, which provides assistance tosmall businesses (under 500 employees) through U.S. Small Business Administration loans primarily to support payrollcosts for affected businesses. While these loans are for a limited period (up to eight weeks), some or all of the loan may beforgiven.

Despite this government aid, it is anticipated that a significant number of lessees will be looking to negotiate short- or long-term lease concessions or other relief from lessors. On April 10, the FASB staff issued a Q&A(https://www.fasb.org/cs/Satellite?c=FASBContent_C&cid=1176174459740&pagename=FASB%2FFASBContent_C%2FGeneralContentDisplay) on FASBASC Topic 842, Leases, and Topic 840, Leases, accounting for lease concessions related to the effects of the COVID-19pandemic.

One topic addressed by the FASB staff is the existing guidance requiring an analysis of whether changed leaseagreements provide enforceable rights and obligations for lease concessions. An absence of enforceable rights andobligations can result in lease modification accounting, where the right-of-use asset and lease liability are remeasuredusing an updated discount rate, and the lease classification as either a finance or an operating lease is reassessed.

The FASB staff concedes that existing guidance did not contemplate the speed and volume of modifications resulting froma major global public health crisis. The FASB staff also acknowledged that absent further interpretative guidance,appropriately analyzing lease modification requirements on the large volume of leases impacted could be costly andcomplex for both lessees and lessors.

A further complication in determining whether lease concessions are consistent with contract terms rather than a contractmodification are the programs implemented or encouraged by governments that permit or require changes to either party'scontractual obligations during the period impacted by the COVID-19 pandemic.

The underlying premise of remeasuring a lease is that the economics of the lease are affected for the remainder of thelease term. The FASB staff understands the view that recognizing lease concessions related to the effects of the COVID-19pandemic over the remainder of the lease term may not reflect the economics of those concessions.

ANOTHER ELECTION TO CONSIDERFASB's staff Q&A provided guidance that it would be acceptable to make an election to account for lease concessionsrelated to the effects of the COVID-19 pandemic as though the lease agreement provides enforceable rights andobligations for lease concessions not requiring lease modification treatment even though the existing agreements do notinclude such provisions. In making this election, an entity will not need to evaluate whether each applicable lease containsthe enforceable rights provisions.

Noted examples include deferred rental payments from three to six months, most initiating in April 2020. Deferred rents arethen to be paid back in addition to base rents mandated in the lease agreements, starting in 2021, amortized over areasonable period. A key point as stated by FASB is that the tenant must be "affected by the economic disruptions causedby the COVID-19 pandemic" and not use the opportunity to take advantage of the general circumstances.

The FASB staff is clear that this guidance can be applied only if lease concessions do not result in a substantial increase inthe rights of the lessor or obligations of the lessee. There is an expectation of exercising reasonable judgment indetermining that the total payments of a modified lease contract will be substantially the same as or less than the originalcontract.

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When concessions result in the deferral of payments with no substantive changes to contract consideration, the FASB staffindicated that there may be several ways to account for the deferral. With no method identified as preferable, two possiblealternatives were presented:

Deferred payments are accrued, with lessors continuing to recognize income and lessees continuing to recognizeexpenses; or

The deferred payments would be accounted for as variable lease payments.

A company's lease accounting software should be able to handle either alternative presented.

Regardless of the method used to account for a lease concession related to the effects of the COVID-19 pandemic, thereshould be appropriate disclosures about material concessions granted (lessors) or received (lessees) and the relatedaccounting treatment used, so financial statement users can understand the financial impact of lease concessions relatedto the COVID-19 pandemic.

Should the lease concessions granted result in substantial changes to consideration, treating the changes as a leasemodification would be appropriate. The lease liability and right-of-use asset would be remeasured with an updated discountrate, and the lease term may change with an updated evaluation of the "reasonably certain" criteria for extension or earlytermination options. These changes could result in determination of a different lease classification. There may also be right-of-use asset impairment considerations that could require appropriate attention.

FASB'S DELAY PROPOSALIn recognition of the business disruptions caused by the new standard, FASB has proposed delaying by one year theeffective dates of its lease accounting standard for certain entities. If approved, the delay to Topic 842 would apply toprivate companies, not-for-profits, and not-for-profit entities that FASB calls public not-for-profits, which have issued or areconduit bond obligors for securities that are traded, listed, or quoted on an exchange or an over-the-counter market andthat have not yet issued financial statements.

The delay for private companies and private not-for-profits would make the standard effective for private companies andprivate not-for-profits for fiscal years starting after Dec. 15, 2021. The effective date for public not-for-profits would be fiscalyears starting after Dec. 15, 2019.

Stephen G. Austin, CPA, MBA, is managing partner, and Joel C. Colbourn, CPA, MBA, is lease accounting director, bothof Swenson Advisers LLP in San Diego; Ane Ohm, CPA, is co-founder and CEO of lease accounting software providerLeaseCrunch in Hartford, Wis.; and Don Mitchell is managing principal of Cresa Global Inc. in San Diego. To comment onthis article or to suggest an idea for another article, contact Ken Tysiac, the JofA's editorial director,at [email protected] (mailto:[email protected]) or 919-402-2112.

Getting leases in line

The sponsored report "Getting Leases in Line" examines what makes FASB ASC Topic 842, Leases, challenging anddescribes new ways for CPAs to add value. To learn more, go to journalofaccountancy.com/leases2020(https://www.journalofaccountancy.com/leases2020).

© 2020 Association of International Certified Professional Accountants. All rights reserved.

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