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5.2 Accounting for a lease modification – lessee
Publication date: 30 Jun 2021
us Leases guide
A lessee and lessor may amend the terms of a lease for a variety of reasons. The ASC 842 Glossary defines a lease modification.
Definition from ASC 842 Glossary
Lease Modification: A change to the terms and conditions of a contract that results in a change in the scope of or the consideration for a lease (for example, a change to the terms and conditions of the contract that adds or terminates the right to use one or more underlying assets or extends or shortens the contractual lease term).
The following are examples of lease terms which may be amended after the lease commencement date:
- A lease extension
- Early termination of the lease
- A change in the timing of lease payments
- Leasing additional space in the same building
5.2.1 Lessee accounting for a lease modification
As illustrated in Figure LG 5-1, a lessee’s accounting treatment of a lease modification depends on the type of modification made to the lease. A lease modification can result in either a separate new contract that is accounted for separate from the original contract or a single modified contract.
Figure LG 5-1
Lessee analysis of a change in a lease
Lessee analysis of a change in a lease
A lessee should account for any direct costs, lease incentives, or other payments made by the lessee or lessor in connection with a lease modification in the same manner as those items would be accounted for in connection with a new lease. See LG 4.2.2.2 for information on direct costs. See LG 3.3.4.2 for information on lease incentives.
5.2.1.1 Separate new contract — lessee
ASC 842-10-25-8 provides guidance on whether a lessee should account for a lease modification as a new contract (separate from the existing contract).
An entity shall account for a modification to a contract as a separate contract (that is, separate from the original contract) when both of the following conditions are present:
a. The modification grants the lessee an additional right of use not included in the original lease (for example, the right to use an additional asset).
b. The lease payments increase commensurate with the standalone price for the additional right of use, adjusted for the circumstances of the particular contract. For example, the standalone price for the lease of one floor of an office building in which the lessee already leases other floors in that building may be different from the standalone price of a similar floor in a different office building, because it was not necessary for a lessor to incur costs that it would have incurred for a new lessee.
An additional right of use is granted when the lease contract is modified to give the lessee a right to use an additional underlying asset that was not included in the original lease. For example, when the floor space under lease is increased or a lessee receives the right to use a new standalone asset. A modification to increase the lease term is not considered an additional right of use.
Accounting for the separate new contract
When a lessee concludes that a lease modification should be accounted for as a new contract that is separate and apart from the original lease, the new contract should be evaluated for whether it is a lease or contains an embedded lease (see LG 2.3 for the definition of a lease). If the new contract is a lease or contains an embedded lease, the new lease should be accounted for as any other new lease (classified as finance or operating and measured accordingly). See LG 3 for information on lease classification and LG 4 for information on lease measurement.
The new lease is recorded on the commencement date of the new lease, which is the date the lessee has access to the leased asset. For example, if a lessee modifies a lease to use additional space in a building, the new lease should be recorded once that space is available for use. See LG 3.2.1 for information on lease commencement.
Example LG 5-1 illustrates a lessee’s accounting for a modification as a separate new lease.
EXAMPLE LG 5-1
Modification that is a separate new lease
Modification that is a separate new lease
Lessee Corp enters into a 5-year lease for 2,000 square feet of warehouse space with Lessor Corp for $10,000 per month.
At the end of year one, Lessee Corp and Lessor Corp agree to amend their lease contract to include an additional 1,000 square feet of warehouse space in the same building for the remaining four years of the lease. Lessee Corp will pay an additional $6,000 per month for the additional space. The additional $6,000 is in line with the current market rate to lease 1,000 square feet of warehouse space in that particular building at the date that the modification is agreed to. Lessee Corp will make one monthly payment of $16,000 per month after the modification. There is no other change in the terms and conditions. The contract for the additional 1,000 square feet of space, and the combined 3,000 square feet of space meet the definition of a lease.
How should Lessee Corp account for this lease modification?
Analysis
Lessee Corp should account for the lease modification as a separate contract because the modification granted Lessee Corp an additional right of use at a price that is commensurate with the standalone price for the additional space. Based on the facts, since the new contract meets the definition of a lease, at the new lease’s commencement date, Lessee Corp would have two separate leases as follows:
- The original lease for 2,000 square feet for four remaining years
- A new lease for the additional 1,000 square feet for four years
5.2.1.2 Single modified contract — lessee
If a lease modification is not accounted for as a separate contract, a lessee should reassess whether the contract contains a lease. If the modified contract is a lease or contains an embedded lease, a lessee should reallocate contract consideration, reassess the lease classification, remeasure the lease liability, and adjust the right-of-use asset. For information about the definition of a lease, see LG 2.3. For information on determining lease classification see LG 3. For information on remeasuring the lease liability and adjusting the right-of-use asset see LG 5.3.3 and LG 5.3.4.
A modified lease could have multiple components. For example, if a lease is modified such that an additional right of use is granted (e.g., additional space is leased) but the modification is not recorded as a separate new contract, there will be two separate lease components in the new modified lease. See Example 17 beginning at ASC 842-10-55-168 for additional information.
A lease may be denominated in a currency that is not the same as a lessee’s functional currency. See LG 8.8 for information regarding what exchange rate a lessee should use to remeasure a right-of-use asset into the lessee’s functional currency when there is a lease modification that is not accounted as a separate new lease.
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