Lease Modifications – Understanding the Implications to Your Financial Reporting
As your lessees understand better the full financial impact of the Covid-19 pandemic on their businesses, your lessees may have, or may be, requesting modifications to their lease agreements with you.
Before you negotiate and commit to any changes to the terms of lease agreements, you should be aware of how they may impact the accounting for leases under generally accepted accounting principles (GAAP) as well as your financial reporting, which in turn may impact requirements and covenants under your agreements with funding sources among others. Common types of lease modifications are rent forgiveness, rent deferral and rent deferral with term extension.
General GAAP guidance under ASC 840 states “If at any time the lessee and lessor agree to change the provisions of the lease, other than by renewing the lease or extending its term, in a manner that would have resulted in a different classification of the lease under the lease classification criteria had it been in effect at lease inception, the revised agreement shall be considered as a new arrangement over its term.” Different guidance would apply if the provisions of ASC 842 have been adopted, but most private entities have not yet adopted ASC 842.
The Financial Accounting Standards Board (FASB) has provided some relief to the general guidance under ASC 840, meaning that a reassessment of the lease classification would not be required. To be eligible for the FASB’s relief however, the modification must be related to the effects of COVID-19 and result in total payments in the modified contract that are substantially the same or less than in the original contract. Changes to the underlying leased asset or short payments generally do not permit the use of the FASB’s relief.
Before agreeing to any lease modifications, consideration should be given to the current credit quality of the customer, their account status and payment history prior to the pandemic, and your overall history and relationship with the customer. In addition, consideration should be given to your Company’s and its system’s capabilities to handle the modifications, and the impact on agreements with outside parties such as assignments and securitizations, as well as the impact on the Company’s liquidity and allowance for credit losses forecasting.
Please contact your ECS representative for more detailed information on the above matters, and to discuss the specific implications of any lease modifications you are considering with your customers.