Many of these businesses are asking their landlords for rent concessions, most commonly payment forgiveness and/or deferral of payments. In response, the Financial Accounting Standards Board (FASB) has developed a Q&A to respond to some frequently asked questions about accounting for lease concessions related to the COVID-19 pandemic.
Under Accounting Standards Codifications (ASC) 842 and 840, changes to lease payments that are not stipulated in the original lease agreement are generally accounted for as lease modifications as of the effective date of the modification. Lease modifications require re-measurement of the lease liability and adjustment to the right-of-use asset. Some lease agreements contain explicit or implicit enforceable rights and obligations that require lease concessions if certain circumstances arise that are beyond the control of the parties of the contract. These are sometimes referred to as “force majeure,” which comprise unforeseeable circumstances that prevent parties from fulfilling a contract. If a lease provides enforceable rights and obligations for concessions in the contract and no changes are made to the contract, the concessions are not accounted for as lease modifications. If concessions are beyond the enforceable rights and obligations in the lease, the concessions are accounted for as lease modifications in accordance with ASC 842 or ASC 840.
The FASB has offered some relief by simplifying the accounting for lease concessions made and received as a result of the pandemic. Entities will not have to analyze each lease agreement to determine if the lessee has an enforceable right to concessions related to the effects of the COVID-19 pandemic and may elect to treat qualifying lease concessions as if they were based on enforceable rights and obligations. This election allows entities the option to apply or not to apply lease modification accounting for these concessions.
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. For example, this election is available for concessions that result in the total payments required by the modified contract being substantially the same as or less than total payments required by the original contract.
The FASB Q&A has outlined two methods to account for deferral of rent payments when electing to not apply lease modification accounting. These two methods are:
- Account for concessions as if no change to the lease contract were made. Under this accounting, a lessor would increase its lease receivable, and a lessee would increase its accounts payable as receivables/payments accrue. In its income statement, a lessor would continue to recognize income, and a lessee would continue to recognize expense during the deferral period.
- Account for the deferred payments as variable lease payments.
Under normal circumstances, with no rent deferral, the lessee records a journal entry with a debit to lease liability and a credit to cash. Under the first method listed above, at the end of the period for which rent is deferred, the lessee would credit a payable instead of cash, relieving this payable when the deferred rent is ultimately paid. Under this method, there are no changes to rent expense, the lease liability or the right-of-use asset compared to traditional accounting.
Correspondingly, the lessor would debit a receivable instead of cash, relieving the receivable as the tenant pays the deferred rent. The lessor continues to record straight-line rental income and there is no change to the amount of rental income recognized for the period.
Under the second method listed above, the lessee records a credit to rent expense in the period of deferral instead of accruing a payable. When the lessee later pays the deferred rent, it recognizes a variable rent expense. There are no changes to the lease liability or the right-of-use asset compared to traditional accounting.
Under this method, the lessor recognizes its normal straight-line rental income and receivable, but also records negative variable rental income and credits the receivable. The lessor recognizes the deferred amount as variable rental income in the period it is subsequently received.
The FASB also emphasizes that entities should provide adequate disclosures about material concessions granted or received, and the accounting effects, to enable financial statement readers to understand the nature and financial effect of lease concessions related to the effects of the COVID-19 pandemic.