Lease Accounting: When Life Gives You Modifications, Make Remeasurements
In order to discuss the topic of lease accounting, I have partnered with LeaseCrunch and lease accounting specialist, Jess, to walk us through the intricacies of ASC 842. Today, we’re exploring the important topic of lease reassessments and modifications. Throughout our conversation, we navigate the sometimes complex landscape of lease term revisions and residual value guarantees.
Josh: Jess, let’s start with the basics. When do lessees need to reassess a lease term?
Jess: Great question. Reassessment is necessary when significant events occur that are within the lessee’s control and affect the likelihood of exercising options to extend, terminate, or purchase the asset. It’s also required when the lessee actually decides to exercise (or not exercise) an option that wasn’t previously factored into the lease term. Think of it as a formal re-evaluation of your commitment to the lease.
Josh: Could you elaborate on what qualifies as a “significant event”?
Jess: Certainly. A significant event could be making major improvements to the leased asset, customizing it substantially, or making a business decision that impacts your lease options. For example, if you construct significant leasehold improvements that would be valuable beyond the current lease term, that’s a trigger for reassessment. It’s about actions that demonstrate a change in your long-term plans for the leased asset.
Josh: How do notice provisions in lease agreements factor into reassessment?
Jess: Notice provisions are critical triggers that companies often overlook. If your lease has an automatic renewal unless you give notice to terminate, and you miss that notice deadline, you’ve triggered a reassessment. For instance, if you have a 5-year lease with an automatic 5-year renewal unless you notify the lessor 6 months prior to the end of the first 5 years, failing to give that notice to terminate the lease means you have auto opted into the renewal and then need to reassess the lease term and remeasure the lease liability and right-of-use asset.
Josh: Let’s discuss residual value guarantees. What are they, and how do they impact lease accounting?
Jess: A residual value guarantee is essentially a promise to the lessor that the asset will be worth at least a certain amount at the end of the lease. This affects the Lease Liability and ROU Assets because this amount is considered to be a future payment. Therefore, if the guaranteed amount changes, you will need to remeasure the lease. This involves updating your lease liability, reallocating consideration to lease components, and adjusting your right-of-use asset. It’s a complex process that requires careful attention to detail.
Josh: Given all these potential triggers for reassessment, how do companies effectively manage their lease portfolios?
Jess: Managing lease portfolios under ASC 842 requires a systematic approach. Many companies use specialized software solutions to track lease terms, notice periods, and potential reassessment triggers. It’s crucial to have good communication between departments, as changes that might seem minor to operations could have significant accounting implications. Regular reviews of the lease portfolio and clear internal processes for reporting changes are also essential.
Josh: What common pitfalls should companies be aware of when it comes to lease reassessments and modifications?
Jess: One of the biggest challenges is ensuring timely communication of lease changes across the organization. Often, modifications are made at the operational level without accounting being informed promptly. Another common issue is underestimating the impact of seemingly small changes, like missing a notice deadline. It’s also crucial to maintain accurate documentation of all reassessments and the rationale behind them for audit purposes.
Josh: Any final advice for our readers navigating the complexities of lease accounting under ASC 842?
Jess: Remember that lease accounting under ASC 842 is an ongoing process, not a one-time event. Stay proactive in monitoring your leases, invest in good systems and processes, and don’t hesitate to seek expert advice when needed. Keeping up with lease modifications and reassessments can be challenging, but with the right approach, it’s manageable. And always keep in mind the potential financial statement impacts of lease changes – they can be more significant than you might expect
If you have any questions regarding ASC 842, please contact us here at ASL.
About the Author
Josh Cross
Josh Cross, CPA, is the in-charge Principal of the ASL Assurance Group. He has over fifteen years of public accounting and audit experience serving privately…
