Lease Accounting Perspectives, Analysis, and Insights Deloitte US

lease termination accounting

Based on the above remeasurement there is a debit to the lease liability of $13,553.14 and the balancing
entry
goes
to the ROU asset. Like with any modification, the lessee is required to update the discount rate at the date effective. Under this approach, the lessee will then need to recognize the difference between the remaining liability calculated ($16,253,988) and the modified liability value (calculated at the beginning of this example as $18,211,776). See Incremental Borrowing Rate for IFRS 16, ASC 842, and GASB 87 for further information on the selection of the discount rate for use in your lease arrangement. If any of the criteria described above are met, then the lease is classified as a finance lease.

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  • This can be taken at face value whereby the lessee would simply calculate the change in the number of floors they have access to or the lessee can determine the square footage of each floor and then calculate the change.
  • In promulgating this guidance, FASB believed that a decision to not sublease the property is separate from the decision to cease using the property.
  • However, the value of the ROU asset will change based on the approach selected.
  • This means that the same lease classification test that was performed at lease commencement is performed again, but with the updated lease terms.
  • The liability recorded at the cease-use date assumes that the property will be subleased.

For example, if the lease liability decreases by 5% based on the new payment terms, the lessee would calculate a 5% reduction in the right-of-use asset value. Any variance between the adjustment to the asset and the liability should be recorded in current period gain or loss. In addition to the termination of the leased asset, the arrangement could change such that the usage of the leased asset is reduced.

Partial termination options broken down by standard

For more information on lease classification, please refer to this article. Non-PBEs that have not yet adopted ASC 842 should work with their accounting advisers when dealing with the real estate rationalization topics described in the previous section and throughout the implementation of ASC 842. Further, entities should review the best practices for adoption below. The COVID-19 pandemic ignited a shift in how entities in almost every industry sector are doing business. Many entities are reevaluating where their employees conduct their required business activities and to what extent they will rely on the use of brick-and-mortar real estate assets on a go-forward basis. Specifically, many entities have already initiated (or may soon initiate) a real estate rationalization program to reevaluate their organization-wide real estate footprint.

lease termination accounting

Although implementation strategies vary, we developed these recommendations on the basis of experiences with public-company implementation. While an entity works toward adoption of ASC 842, the entity’s normal operations do not cease; new leases are entered into, and existing leases are modified or terminated. Accordingly, the adoption of ASC 842 should not be viewed strictly as a linear process. In implementing ASC 842, entities will need to change not only their accounting for and financial reporting of leases but also their related systems and processes. It is important for all entities to develop an implementation plan well before ASC 842’s effective date.

Approach 1: proportionate change in the lease liability

Although some of the accounting changes may seem intuitive, the necessary data and systems changes are significant and, without preparation, may be overwhelming. Partial terminations are one of the most complex areas of the lease accounting standard. Like many aspects of lease accounting on face value, the accounting appears straightforward. When a lease has been terminated in its entirety, the lessee should no longer recognize a right of use asset and a lease liability. ASC 842 provides two alternatives to recognize the reduction in the asset.

The lease commences on January
1, 2020, for a 5-year term, with Curve paying in advance $10,000 per annum. That’s because, unlike other modifications where there is no income statement impact, with partial lease termination, there is. This occurs when, for whatever reason, the lessee abruptly terminates the lease. In doing so, the lessee no longer has access to the right of use asset and no future lease payments. Depending on the facts and circumstances of the lease agreement, the lessee may be required to make a termination payment.

Remeasuring the right-of-use asset

Finally, the difference between the post-modification lease liability and the right of use asset post-modification is taken to the income statement. Any difference between the reduction in the lease liability and the proportionate reduction in the right-of-use asset shall be recognized as a gain or a loss at the effective date of the modification. If you’re a small business reporting under FASB or IASB standards, LeaseGuru powered by LeaseQuery might be the right lease accounting solution for you.

lease termination accounting

Example 17 – Modification That Decreases the Scope of the Lease within IFRS 16 illustrates the approach to account for for partial terminations. As above, the difference between the reduction in the liability and proportionate change in the ROU asset will be recognized as a gain or loss (IFRS 16.46). Next, the lessee should remeasure the lease liability based on the revised lease payments in the modified contract using the discount rate as of the effective date of the partial termination.

Lease Accounting focus areas—watch the videos

We will address the accounting for a partial termination, and the differences between the treatment within the respective standards, below. Upon determining there is a partial termination, the lease classification needs to be reassessed. This means that the same lease classification test that was performed at lease commencement is performed again, but with the updated lease terms. This article provides a full example of when a modification changes a lease classification from operating to finance. If the new terms of the agreement reduce the rights to the underlying asset(s), then it is referred to as a partial or full termination.

At the start of year two, Curve renegotiates the contract to lease only two of the factories. Once you have viewed this piece of content, to ensure you can access the content most relevant to you, please confirm your territory. The lessee would next calculate the remaining liability as the lease liability before modification ($27,089,980) less the proportionate lease liability reduction lease termination accounting ($10,835,992), resulting in a remaining liability of $16,253,988. In this example, the original terms of the agreement state that the lessee will lease five floors. This can be taken at face value whereby the lessee would simply calculate the change in the number of floors they have access to or the lessee can determine the square footage of each floor and then calculate the change.

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