As the COVID-19 pandemic forces many lessees to reevaluate their real estate requirements, the lease options they choose to exercise could call for a reassessment of lease classification and a remeasurement of lease liability and right-of-use (ROU) asset.
A lessee is required to reassess lease terms if a triggering event occurs that is within the lessee’s control or affects the likelihood of option exercise. Per guidance under ASC 842-10-15-36, a lessee shall remeasure and reallocate the consideration in a contract.
Examples of Triggering Events for Lease Reassessments
- Construction of significant leasehold improvements.
- Subleasing an asset for a period beyond end of the current lease term.
- Significantly modifying or customizing the asset.
- Making a business decision directly relevant to option exercise.
In a previous article, we discussed events or changes to a lease contract that can result in a lease modification. Here we will highlight the decision-making process in assessing whether a lease reassessment triggering event has occurred, whether a remeasurement trigger has occurred for ROU assets and lease liabilities, and what the associated accounting treatments and considerations are as a result of such triggering events.
Triggers and Accounting Treatments for the Remeasurement of Right-of-Use Asset and Lease Liability
As presented in Figure 1, any of the following circumstances can trigger remeasurement of ROU asset and lease liability:
- Lease contract term modifications that do not qualify as a separate contract.
- Change in assessment of purchase option exercise likelihood.
- Change in probable amount due under residual value guarantee.
- Resolution of contingencies that result in variable payments converting to fixed payments for the remainder of the lease term.
Following are the appropriate accounting steps for the four triggers presented above:
Conclusion: Continued Monitoring for Triggering Events and Proper Accounting Treatment
Companies should continue to monitor for triggering events as the COVID-19 pandemic forces many lessees to reevaluate their real estate requirements and lease options they choose to exercise. This is different from current GAAP, which did not require monitoring. Ensure proper accounting treatment accounting is being applied and that disclosures are adequate for financial statement users to understand the impact of reassessments. Also, visit our article on Accounting for Lease Modifications as a Result of COVID-19 for certain tax considerations related to lease modifications and reassessments.
For more information, visit our website regarding implemention of ASC 842, or contact us at firstname.lastname@example.org.