The COVID-19 pandemic has severely affected the global economy and significantly disrupted business operations. As a result, many lessors are, or will be, providing lease concessions to lessees. While these concessions vary, payments forgiveness and deferral are expected to be the most common types. Because of the widespread effects of the pandemic, lease concessions are expected to be for substantial numbers of lease contracts for both lessor and lessees.
In order to provide interpretative guidance, the FASB staff developed a Q&A to answer some frequently asked questions. The Q&A apply to entities that have leases affected by the economy disruption caused by the COVID-19 pandemic.
Background to the Issue
Changes to lease payments that are not included in the original lease contract are generally accounted for as lease modifications. As with IFRS 16, for lessees this would result in the lease liability being regulated at the date of modification, with the revised lease payments being discounted at an updated discount rate determined at that date. Lessors would also account for a lease modification.
The key point addressed in the Q&A is whether concessions granted by the lessors as a result of the COVID-19 pandemic could be required to be accounted for by lessors and lessees as lease modifications. If so, then lessors and lessees would have to carry out a detailed analysis of the requirements of each lease contract to determine whether the original contractual terms included a provision for revised lease payments on the occurrence of an event such as the COVID-19 pandemic. If not (and, generally speaking, lease contracts do not contemplate these changes) the lease modification guidance would have to be applied to each individual lease. This could be complex and costly.
Question 1: Are lease modification related to the effects of the COVID-19 pandemic required to be accounted for in accordance with the lease modification guidance in topic 842 and topic 840?
The FASB staff note that, due to the unprecedented and global nature of the COVID-19 pandemic, it may be very difficult for entities to determine whether existing lease contracts contain enforceable rights and obligations for lease concessions and, if they do, whether the concessions actually granted as a result of the COVID-19 pandemic would be consistent with the contractual terms or would instead be lease modifications. The analysis may become even more complex as a result of government programmes which could encourage or require lessors to grant payment holidays or defer payments to later dates. Consequently, without interpretative guidance, the application of the lease modifications requirements in Topic 842 and Topic 840 could be both complex and costly.
Although the guidance in those standards deals with lease concessions made in the ordinary course of business, the FASB staff believes that this guidance did not complete the wide ranging and significant concessions that are being made as a result of the CVOID-19 pandemic. It is also acknowledged that the recognition of the effects of those lease concessions over the remaining term of the lease (as would be required by modification accounting) may not reflect the economics of the concessions.
The FASB staff consider that it is appropriate to make an accounting policy choice available to entities. This policy choice would enable entities to account for lease concessions made as a result of the COVID-19 pandemic ‘as though enforceable rights and obligations for the concessions existed (regardless of whether those enforceable rights and obligations for the concessions explicitly exist in the contract).’ This means that if entity chooses to apply the relief made available by the accounting policy choice, the entity will not need to carry out a lease-by-lease-analysis.
The accounting policy choice is available for only those concessions that relate to the COVID-19 pandemic that do not result in substantial increase in the rights of the lessee or obligations of the lessor. As an example, it would be available for concessions that result in the total payments requirement by the modified contract being substantially the same or less than total payments required by the original contract. ‘Substantially the same’ is not defined, with entities being expected to apply reasonable judgement in making the determinations.
It is noted that some lease concessions will result in the deferral of payments, meaning that the total amount of lease payments remains the same, but the timing of payments is different. The FASB staff note that there are multiple ways of accounting for those deferrals, and that in view none are more preferable than the others. Two are identified in the Q&A, being:
- Account for the concession as if no change to the lease contract were made, with lease income (lessor) and lease expenses (lessee) continuing to be recognised during the deferral period; or
- Account for the deferred payments as variable lease payments.
Question 2: Is an entity precluded from accounting for lease concessions related to the effects of the COVID-19 pandemic by applying the lease modification guidance in topic 842 and topic 840?
Because the application of the approach set out in the Q&A is an accounting policy choice, an entity is still permitted to apply the lease modification accounting guidance.
Question 3: Does an entity have to account for all lease concessions related to the effects of the COVID-19 pandemic either (a) as if the enforceable rights and obligations to those concessions existed in the original contract or (B) in accordance with the lease modification guidance in topic 840 and topic 842?
Entities are not required to apply a single approach to all leases. However, it is noted that, cinsitent with the requirements of paragraph 842-10-1, Topic 842 should be applied consistently to lease with wimilar characteristics and in similar circumstances.
Question 4: Should an entity provide disclosure about lease concessions related to the effects of the COVID-19 pandemic?
Disclosures are required about material concessions given (lessors) or received (lessees) and the accounting effect. These need to be sufficient to enable users of financial statements to understand the nature and financial effect of those lease concessions.
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