Cash Flow Opportunities and Accounting Considerations for ASC 842
by Matt Waters, CPA on July 10, 2020
Originally Published June 2020 by CFO Magazine.
The economic fallout from COVID-19 is causing an unprecedented number of challenges and lease changes for many companies. But it also presents new opportunities for harnessing lease data to conserve and generate cash. Here are a few ways to identify such opportunities, execute on them, and report the audit-ready results in compliance with new lease accounting standards.
Lessees can save cash immediately with lease concessions, which forgive or defer the payment of rent. Because the economic effects of COVID-19 have been so severe, even without any enforceable rights to lease concessions, many lessees have requested and received concessions.
At the beginning of the pandemic, these non-enforceable concessions presented an accounting challenge because rules under ASC-842 stipulated they should be treated as a lease modification. However in April 2020, the FASB said companies may now elect to account for COVID-19 lease concessions as if enforceable rights exist. This allows companies to account for lease concessions as variable lease payments, simplifying the accounting process.
The fastest way to identify contracts with entitlement to lease concessions is with lease management software that allows companies to quickly assemble all leases with enforceable rights to concessions so that rent payments can be stopped. When enforceable rights don’t exist, the software can automatically send a request for lease concessions to the applicable lessors. After concessions have been secured, the software can automatically apply modification or variable expense treatment and provide a comprehensive audit trail.
Partial Termination, Full Termination, and Abandonment
As employees work from home and people shop more often online, companies realize they may need to right-size their lease portfolio. A comprehensive lease management software solution can provide companies with visibility into their asset utilization and cost. When utilization does not justify the cost, the software can also report on available and upcoming options to decrease or eliminate rent.
Partial Termination – Companies may be able to modify leases and reduce space. ASC 842 provides two accounting options to reduce the right-of-use asset after a partial termination.
1) Lessees may reduce the ROU asset proportionate to the reduction in the lease liability.
2) Lessees may reduce the ROU proportionate to the reduction in the leased space.
Regardless of the selected option, lease accounting software should be able to remeasure the lease amortization schedule, automatically record journal entries, and document workflows and approvals for audit support.
Full Termination – Companies may need to make strategic decisions to close locations and discontinue the use of some leased assets. There may be an option for a full termination under the lease. If there is a full termination, lease management software should be able to automatically post termination journal entries to remove asset and liability balances and record any gain or loss.
Abandonment – If options don’t exist to partially or fully terminate a lease, companies may decide to abandon a leased asset but retain liability to make lease payments. This saves operating costs associated with the location.
Regardless of the cost-saving method used, lease management software should be able to accept the change and automatically generate journal entries and supporting documentation for reconciliation, roll forward, and disclosure reports. When a property has been abandoned, the lease management software’s built-in market comps can help companies evaluate opportunities for sublease income.
Some of the most common opportunities for lessees to recover cash include:
- Refundable security deposits
- Unpaid tenant improvement allowances
- Previous overpayment of rent
- CAM reconciliations
- Cotenancy violations
- Force majeure clauses
- Evergreen fee avoidance
Lease management software helps companies recover cash by allowing them to quickly identify leases with the above opportunities.
Sale Leaseback Transactions for Real Estate and Equipment
Companies can acquire cash with sale leaseback transactions, which are used to monetize corporate real estate and equipment portfolios. A sale leaseback transaction occurs when the seller transfers an asset to the buyer, and then leases the asset from the buyer. In this transaction, the buyer (or lessor) is typically a finance company or institutional investment organization.
New leases that result from sale leaseback transactions fall under ASC 842 lease accounting guidance, which requires recording ROU assets and lease liabilities. For large portfolios, this could take days, but lease management software with accounting functionality can accept an upload of hundreds or thousands of new leases in seconds and help companies meet ASC 842 accounting requirements.
Matt Waters, CPA is the Director of Lease Accounting for CoStar.
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