Welcome back and happy holidays! In case you missed my first post, I took the time to explore the impact of loan modifications directly related to the novel Covid-19 virus, and the effect they have had on lender financial reporting.
In this next post, I will explore a topic we are all too familiar with by this point: working remotely. For many of us, Covid-19 has turned the occasional work-from-home into the “new normal.” Today I want to dive into the resulting impact this will have on Lease Accounting as many companies begin to close the books on Q4 and prepare FY20 annual reports.
2021 New Years Resolution: Cut Costs.
Leasequery had recently released a report illustrating the decreasing foot traffic across office space as the pandemic forced companies globally to adapt to a remote working environment, one in which is most likely to continuously play a role in our post-pandemic days.
As part of the study, Leasequery interviewed over 400 accounting and finance executives on how the pandemic and current economic environment has shifted the core priorities of their Accounting & Finance departments upon entering 2021.
The results?
66% reported that priorities will focus on cost-cutting
63% focused on increasing flexibility
45% on bolstering liquidity.
“With two-thirds of accounting and finance executives reporting that cutting costs is a bigger priority for their company to stay in business in 2020, the key challenge will be where and how to trim budgets. Reassessing real estate and lease portfolios appear to be top targets for cost savings following the rise of the remote workforce, shifts in demand, and declines in traditional brick-and mortar commerce.” - Leasequery
Lights are on and everybody’s home
The motive to focus on evaluating future need for office space as a cost-cutting measure can be further substantiated by looking at Moody’s COVID-19 CRE Impact Dashboard. At the time I write this, it is projected that vacancy rates for office space will surpass 19% in 2021, nearing 20% by 2023.
I think we can all agree that spending money on underutilized assets is never fun, and that headache becomes increasingly amplified as your income (or sales) begin to fall as well.
“Faced with plunging sales that have already led to tends of millions of layoffs, companies are trying to renegotiate their office and retail leases — and in some cases refusing to pay — in hopes of lowering their overhead and surviving the worst economic downturn since the Great Depression. This has given rise to fierce negotiations with building owners, who are trying to hold the line on rents for fear that rising vacancies and falling revenues could threaten their own survival.” - NY Times
Time for negotiation?
Per Leasequery’s report, we are able to see that 29% of survey participants have asked for rent concessions during Covid-19. With lessors still hoping to collect payment during these unprecedented times, the table is open for negotiation, or should I say, renegotiation.
As companies have taken measure to conserve cash, rent concessions have been a popular topic of discussion. For a lessee in need, the goal is to postpone and/or avoid making rent payments. For example, these rent concessions could consist of (1) free or reduced rent, (2) interest-free deferral of rent payments, or even (3) cash payment to lessees for disrupted operations resulting from Covid-19.
Now rent concessions are great, but from a financial reporting standpoint, there still seems to be a common concern…
“Whether concessions related to the effect of COVID-19 are required to be accounted for in accordance with the lease modification guidance in ASC 842 or ASC 840.” - BDO
FASB to the rescue!
During their April 4th Q&A, the Financial Accounting Standards Board addressed the the concern above by providing an election for accounting treatment, which in summary, suggests Companies may:
Continue to account for the rent concession in accordance with the lease modification guidance in ASC 842 or ASC 840; or…
Elect to not apply lease modification guidance, therefore, avoiding the need to analyze individual contracts in order to determine whether enforceable rights and obligations for concessions exist.
I have copied the illustration below from BDO’s insight report on Accounting for Lease Concessions Related to COVID-19:
Consistency is 🔑
For Companies electing to not apply the lease modification guidance for eligible rent concessions, the following approaches, per FASB’s guidance, were highlighted in PwC’s Accounting Podcast with Partner Chad Soares and Director Marc Jerusalem:
Variable Rent Model: The lessee will account for the rent concession as a negative variable lease payment in the impacted period while later recording the positive variable lease payment in a subsequent quarter. As a result, the following method will reflect the timing issue via the Company’s income statement.
Accrual Model - Rent Deferral: Rather than having an effect on the income statement, the following approach will be reflected on the Company’s balance sheet. Under this method, the Company will credit their Account Payable account rather than cash, reflecting the obligation for rent until paid at a later date.
Whether it is electing for, or against, using the loan modification guidance, it is important to remember that consistency is key.
“The choice is not an accounting policy choice, meaning I can do different things for different types of concessions, but the expectation is I’m going to be consistent in like-concessions. So if concessions are similar, I am going to account for them in a similar way.” - Partner Chad Soares, PwC
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