By Amy Rybar Menefee, CPA, CFE, Business Assurance & Advisory Services Senior Manager
How to Account for Subsequent Measurement of Lease Payments
Under Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-02, there is specific guidance on how to account for subsequent measurement of lease payments.
The first step is determine if the modification, extension or amendment should be accounted for as such, or whether it should be accounted for as a separate contract. In accordance with ASC 842-10-25-8, the modification should be accounted for as a separate contract if it grants the lessee an additional right of use not included in the original lease, for example, the right to use an additional asset. In addition, the lease payments must have increased commensurate with the standalone price for the additional right of use, adjusted for the circumstances of the particular contract. For example the standalone price for the lease of one floor of an office building in which the lessee already leases other floors in that building may be different from the standalone price of a similar floor in a different office building, because it was not necessary for a lessor to incur costs that it would have incurred for a new lease. If both of the conditions are met, the modification should be accounted for as a separate contract.
The discussion below is applicable once the determination has been made that the modification is just that, a modification, and should not be accounted for as a separate contract.
Under the guidance in ASC 842, the lessee should remeasure the lease payments if any of the following modifications occur:
- A contingency that exists in the lease related to variable lease payments to be paid over the remaining lease term is resolved. For example, the variable lease payments become fixed payments for the remainder of the lease term. Note that a change in the rate on which the variable lease payments are based does not constitute a resolution of the contingency. However, if there is resolution of a contingency and the rate also changes, the variable lease payments should be remeasured using the index or rate in effect as of the date the re-measurement is required.
- There is a change in –
- The lease term – the lessee shall determine the revised lease payments based on the revised lease term. Note that the lessee should reassess the lease term if (1) there is a significant event that the lessee can control that directly affects whether the lessee is reasonably certain to exercise or not to exercise an option to extend or terminate the lease, (2) there is an event written into the lease contract that obliges the lessee to exercise an option to extend or terminate the lease, (3) the lessee elects to exercise an option even though the entity has previously determined the lessee was not reasonable certain to do so, or on the contrary, (4) the lessee elects not to exercise an option even though the entity had previously determined that the lessee was reasonably certain to do so.
- The assessment of whether the lessee is reasonably certain to exercise or not to exercise an option to purchase the underlying asset – the lessee should determine the reviewed lease payments to reflect the change in the assessment of the purchase option.
- Amounts probable of being owed by the lessee under the residual value guarantees, which is a guarantee made to a lessor that the value of the underlying asset returned to the lessor at the end of a lease will be at least a specified amount – the lessee should determine the revised lease payments to reflect the change in amounts probable of being owed by the lessee under the residual value guarantees.
The FASB’s goal in issuing ASU 2016-02 was to increase transparency and comparability among organizations by recognizing lease assets and liabilities on the balance sheet and disclosing key information about leasing arrangements. Leasing arrangements are entered into by many entities and it is not unusual for modifications in leasing arrangements to take place during a lease term. Therefore it is important to understand the proper accounting for lease modifications.
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The information contained within this article is provided for informational purposes only and is current as of the date published. Online readers are advised not to act upon this information without seeking the service of a professional accountant, as this article is not a substitute for obtaining accounting, tax, or financial advice from a professional accountant.