Your Accounting Playbook to Lease Modifications and Terminations
Lease modifications and terminations are common occurrences in the ever-changing business landscape. Understanding the accounting treatment for these changes under ASC 842 can be challenging, but it's essential for accurate financial reporting. In this blog post, we'll dive into lease modifications and terminations, explaining how to account for them under ASC 842.
A lease modification occurs when there is a change in the lease terms, such as an extension or reduction of the lease term, a change in the leased asset, or a change in lease payments. Under ASC 842, lease modifications are accounted for in one of two ways, depending on whether the modification results in a separate lease.
Modifications Resulting in a Separate Lease
If the lease modification grants the lessee an additional right-of-use (ROU) asset and its consideration is commensurate with its standalone price, the modification is treated as a separate lease. In this case, the original lease remains unchanged, and the lessee accounts for the new lease separately.
Modifications Not Resulting in a Separate Lease
If the modification does not result in a separate lease, the lessee must remeasure the lease liability using the discount rate at the time of the modification. The ROU asset is then adjusted based on the remeasured lease liability, with any difference recognized in the income statement as a gain or loss.
A lease termination occurs when the lessee and lessor agree to end the lease before the end of the original lease term. Lease terminations can be either full (terminating the entire lease) or partial (terminating a portion of the lease).
Accounting for Lease Terminations
When a lease is terminated, the lessee must remove the ROU asset and lease liability from the balance sheet. Therefore, the difference between the carrying amounts of the ROU asset and lease liability is recognized as a gain or loss in the income statement.
For a full termination, the lessee derecognizes the entire ROU asset and lease liability. For a partial termination, the lessee derecognizes a portion of the ROU asset and lease liability based on the proportion of the leased asset that has been terminated.
Navigating lease modifications and terminations under ASC 842 can be complex, but understanding the accounting treatment for these changes is crucial for accurate financial reporting. By identifying whether a lease modification results in a separate lease or not and accounting for lease terminations based on the type of termination, businesses can confidently manage their lease accounting under ASC 842. With this knowledge in hand, you'll be better prepared to tackle lease modifications and terminations with ease.
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