Accounting for Rent Concessions Due to COVID-19

As the COVID-19 pandemic continues to economically affect significant sectors of the economy, many real estate owners have agreed to provide their tenants with rent concessions that were not stipulated in the original lease agreements. These concessions are taking various forms and include reduced rent (cash payment forgiveness) and deferral of rent payments.

Under Accounting Standards Codifications (“ASC”) 842 and 840, changes to lease payments that are not stipulated in the original lease agreement are generally accounted for as lease modifications as of the effective date of the modification. In addition, some lease agreements provide the lessee with explicit or implicit enforceable rights and obligations that require lease concessions if certain circumstances arise that are beyond the control of the parties of the contract, such as a force majeure clause, or the laws in the jurisdiction governing the lease may create an enforceable right when a concession is legally required.

Thus, if a lease agreement provides these rights and obligations, then the concession may not be considered a lease modification. If it is not, then the concession is likely a lease modification, which requires an evaluation of the lease classification for the lessor and lessee. Accordingly, the evaluation will depend on whether the lease agreement or applicable law provides for changes to payments when particular events occur or circumstances arise and whether the COVID-19 pandemic constitutes such an event or circumstance. This analysis may require legal assistance and is required to be performed on a lease-by-lease basis. In addition, determining whether a modification has taken place and applying the guidance can be operationally challenging, particularly for real estate companies with large portfolios of leases that have various terms and conditions, or entities with a lack of resources.

As a result, the Financial Accounting Standards Board (“FASB”) staff in April 2020issued a Q&A addressing the accounting for rent concessions related to the effects of the COVID-19 pandemic under ASC 842 and 840. Regardless of which ASC a company follows, the guidance related to accounting for lease concessions from the effects of COVID-19 remains similar. The staff Q&A states that an entity may make an election to treat a lease concession related to COVID-19 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 lease agreement. As such, the company would account for the concessions in the current period. Accordingly, making this election would simplify the accounting. However, to qualify for the election, the concessions must relate to the COVID-19 pandemic that do not result in a substantial increase in the rights of the lessor or the obligations of the lessee.

The election would be available for concessions that result in the total payments required by the modified lease agreement being substantially the same or less than total payments required by the original lease agreement. However, the FASB staff did not define “substantially the same.” Instead, the staff expects companies to apply reasonable judgement in making the determination. If the election is made and the substantial increase criteria has not been met, the election not to apply the modification accounting guidance in ASC 840 and 842 to lease concessions granted as a result of the COVID-19 pandemic should be made consistently for leases with similar characteristics and in similar circumstances. In other words, the election may be made on a portfolio-by-portfolio basis. Thus, a real estate company will not need to evaluate each lease agreement for such clauses and can avoid lease modification guidance.

Rent Deferrals with No Substantive Changes in Consideration

The FASB staff stated in the Q&A that a deferral of payments affects the timing, but the amount of consideration is substantially the same as required in the original contract. Accordingly, the FASB staff mentioned that there were at least two acceptable approaches—noting no preference in the approach selected—to account for rent deferrals with no substantive changes to the consideration in the original contract:

• Account for the lease concession as if no changes were made to the lease contract. The lessor would continue to recognize income and a lessee would continue to recognize expense during the deferral period as though the lease was unchanged. The lessor’s balance sheet would reflect an increase in the lease receivable, and the lessee’s balance sheet would reflect an increase in the lease payable.
•   Account for the deferred payments as variable lease payments, in which case the lessor would recognize revenue and the lessee would recognize expense in the period in which such payments actually occur. In practice, the lessor would continue to recognize income and a lessee would continue to recognize expense during the deferral period as though the lease were unchanged. However, the lessor would also recognize the concession as negative variable rent in the period the concession relates, reducing income by the rent concession for the month. The lessee would recognize the concession as a reduction of recognized expense. Where the lease provides for fixed rent increases over the original lease term, there could be a difference between the straight-line rent recognized under the original lease agreement and the rent concession recognized as a negative variable lease payment.

Accounting for Lease Concessions within the Modification Framework

If a company does not make an accounting policy election, either on an entity-wide basis or by asset class, to account for COVID-19 rent concessions using the FASB’s staff Q&A, entities would account for any adjustments to rent payments as a modification in accordance within the applicable lease guidance of ASC 842 or 840.

Disclosures

The FASB staff noted that an entity should provide disclosures about material concessions granted (lessors) or received (lessees) and the accounting effects to enable users to understand the nature and financial effect of the lease concessions related to COVID-19.

Effective Date of ASC 842 for Private Companies and Certain Not-for-Profits (“NFPs”)

The FASB decided to defer the effective date of ASC 842 by an additional year for private companies and certain NFPs. Specifically, for private companies and private NFPs, the leasing standard will be effective for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022. For public NFPs that have not yet issued financial statements or made financial statements available for issuance as of June 3, 2020, the leasing standard will be effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Early adoption continues to be permitted.