leaseaccounting

BY GARY KRAUSZ , CPA / CFF

However , the “ fix-it and forget-it ” Excel templates aren ’ t the end of the discussion . Times change , and leases change , and the changes to the terms and features of existing leases , called “ lease modifications ” remain .

Understanding the challenges of how to assess and account for lease modifications is crucial for companies to ensure compliance and accurate financial reporting . “ Lease modification ” can refer to any of the following changes :

• Extending or shortening the lease terms ;

• Changing the lease payments ; and / or

• Altering the leased asset ’ s scope . ASC 842 categorizes lease modifications into two types : those that result in a separate contract and those that do not . The key is determining which modifications result in treating as a separate contract ( e . g . a new lease ) and which are treated as modifications to an existing lease ( e . g . keep the old lease but recompute the ROU assets and liabilities ).

The existence of both of the following two conditions gives rise to the separate contract ( e . g . new lease ) scenario :

• Increase in scope : The modification adds the rights to use one or more underlying assets that were not part of the original lease , and

• Commencement at market rate : The increase in lease payments reflects the standalone price of the additional right-of-use asset , adjusted for current circumstances . If both conditions are met , the modification is treated as a new lease and the existing lease remains unaffected . Both the lessee and the lessor recognize a new lease contract , and the lessee recognizes a new rightof-use asset and a corresponding lease liability , while the lessor recognizes a new lease receivable or investment in the lease ( depending on whether the lease is a finance or operating lease ). Both lessee and lessor recognize a new lease component , without adjusting the original lease .

When there are modifications that are not treated as a separate lease , these are accounted for as a change to an existing lease . This requires the remeasurement of the existing lease liability and ROU asset . The accounting treatment depends on whether the modification is considered a change in the lease scope or a change in the lease payments . Examples include :

• Change in lease term ( increase or decrease )

• Change in the consideration per the lease ( e . g . variable payment becomes fixed )

• Partial or complete termination of the lease

• Change in assessment of purchase option being exercised

• Change in amount probable of being owed under a residual value guarantee

• Change in scope caused by addition or removal of assets Generally , this reassessment occurs at the time of a triggering event , which is the date that the modifications are recorded . Examples of triggering events :

• Start of construction of significant leasehold improvements

• Business decisions that make renewal reasonably certain

• Subleasing into a renewal period

• Other renegotiation points in time ( e . g . lease concession from landlord )

What You Need to do Depends on the Type of Modification Partial or Full Termination : If the modification partially or fully terminates the lease , the lessee will reduce the carrying amount of the ROU asset and lease liability to reflect the revised lease term or scope . Any difference between net carrying amount reduced and the consideration paid ( received ) for termination is recognized on the income statement as a gain or loss on lease modification .

Change in Terms : For modifications that amend the lease term , payments or other terms without terminating the lease , the lessee must remeasure the lease liability using a revised discount rate as of the effective date of the modification . The revised lease liability reflects the present value of the remaining lease payments under the modified lease terms . The lessee adjusts the ROU asset by the difference between the previous lease liability and the remeasured lease liability .

Change in Scope Without a New Lease Component : If a modification changes the scope of the lease ( e . g ., adding or removing the right to use a portion of the leased asset ) without adding a new lease component , the lessee must reallocate the consideration in the contract to the modified lease components . The lease liability is remeasured , and the ROU asset is adjusted accordingly . If the remeasurement results in a reduction of the ROU asset to zero , any excess is recognized in profit or loss .

The following chart illustrates what changes when the remeasurement or modification accounting is required : www . calcpa . org OCTOBER 2024 CALIFORNIA CPA 19