Due to the onset of the Covid-19 pandemic and its subsequent impact on businesses, many companies are struggling to make lease payments. In some cases, businesses have paused making rent payments, while others have reached out to their landlords to request adjustments to the terms of their leases. In response, lessors may offer lease concessions, consisting of either deferred lease payments or forgiven rent.

Under U.S. GAAP, in particular ASC 840 and 842 lease guidance, companies (lessors and lessees) must consider very specific Lease Modification Provisions when a lease is modified or when certain triggering events, including changes to lease payments, occur.

What are the Lease Modification Provisions under ASC 840?

Companies that have not adopted ASC 842 and are subject to Lease Modification Provisions under ASC 840 should determine whether a new lease has been created as a result of the lease concessions. If a new lease has not been created, the company should adjust the existing asset or obligation balances for the lease concessions.

What are the Lease Modification Provisions under ASC 842?

Companies that have adopted ASC 842 should consider whether lease concessions result in an entirely separate contract, or simply a modified contract. Additionally, lessees should consider evaluating right-of-use assets recognized under ASC 842 for impairment. These assets could become impaired as a result of business closure due to reduced usage or receipt of order to shut down from a local jurisdiction.

Are lease concessions resulting from COVID-19 subject to Lease Modification Provisions?

To determine whether lease concessions resulting from Covid should be accounted for as lease modifications, companies must consider whether enforceable rights exist to the lease concessions under the original lease contract. If enforceable rights do not exist, the concessions are accounted for as a lease modification. If enforceable rights do exist, the concessions are accounted for under the original lease as contingent payments.

As most lease concessions resulting from Covid are not explicitly provided for in the original lease contract, or are not enforceable, questions arose as to how to account for these concessions. FASB clarified that companies have the option to opt out of the Lease Modification Provisions of ASC 840 and 842. Opting out would mean that companies can skip the step of determining whether enforceable rights to the lease concessions exist under the original lease contract.

How do companies know whether they can opt out of applying the Lease Modification Provisions?

To determine whether a company can opt out of applying the modification provisions, it must consider the following questions:

• Are the lease concessions related to effects of Covid and agreed to by all parties of the lease?
• Do the lease concessions not result in a substantial increase to the obligation of the lessee or rights of the lessor?

If the answer to any of these questions is “no,” the company cannot opt out of applying the modification provisions under ASC 840 and 842. The company should then determine whether the original lease terms explicitly provide for possible lease concessions resulting from Covid to account for the concessions as a lease modification or contingent payments.

If the answer to all these questions above is “yes,” the company can elect to not apply the modification accounting guidance under ASC 840 and 842.

How should companies account for the lease concessions if they opt out of applying the Lease Modification Provisions?

Once a company has determined that it can opt out of applying the modification provisions, it should consider whether the lease concessions affect only the timing of future lease payments or whether future lease obligations have been forgiven.

If the lease concessions affect only the timing of future lease payments, the company can choose to account for the deferred payments on an accrual basis or as contingent payments.

• Under the accrual basis of accounting, a lessee would have a growing liability on its balance sheet and continue to recognize regular lease expenses. Similarly, a lessor would have a growing receivable on its balance sheet and continue to recognize regular lease income. However, lessors should consider evaluating existing lease receivables for impairment. If the objective is to continue reporting lease income in the current period or to reflect the growing liability from lease concessions, the lessor or lessee may choose to account for lease concessions under the accrual basis of accounting.
• Under the contingent payment method of accounting, companies would defer recognition of lease expense or income to a later period when the rent is paid. While this can allow for net zero lease expense or income in the period the contingent payment is recorded, it also results in the recognition of higher lease expense or income in the period that the rent is paid and contingent rental expense or income is recorded. If the objective is to defer recognition of lease expenses in the current period, companies may wish to account for lease concessions under the contingent payment method.

If the lease concessions result in forgiven lease payments, companies can choose to account for the forgiven rent as contingent payments as described above, or as a lease modification.

Under the lease modification method of accounting, companies would re-amortize the forgiven lease amount over the remaining lease term. Companies may wish to account for lease concessions under this method to spread the recognition of forgiven lease amounts, whether income or expense, over the remainder of the lease.

Additional considerations

Whether a company opts out of applying the Lease Modification Provisions, or is subject to modification provisions under ASC 840 or 842, it must disclose the nature and financial impacts, if significant, of all lease concessions received or offered.

Decision tree

We understand how complex this can be — we’ve created the below decision tree to help simplify things.

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