A lease may be denominated in a currency that is not the same as a lessee’s functional currency. As discussed in ASC 842-20-55-10
, a lease liability is a monetary liability and a right-of-use asset is a nonmonetary asset. Therefore, a lease liability should be remeasured using the current period exchange rate at the reporting date with any changes recognized in the income statement. However, the right-of-use asset should be measured at the historical exchange rate at the commencement date and is not affected by subsequent changes in the exchange rate.
The right-of-use asset is a nonmonetary asset while the lease liability is a monetary liability. Therefore, in accordance with Subtopic 830-10 on foreign currency matters, when accounting for a lease that is denominated in a foreign currency, if remeasurement into the lessee’s functional currency is required, the lease liability is remeasured using the current exchange rate, while the right-of-use asset is remeasured using the exchange rate as of the commencement date.
As discussed in LG 4.4.2
, operating lease expense is a single line item in the income statement that is the sum of right-of-use asset amortization and accretion of the lease liability. We believe remeasurement of operating lease expense into a lessee’s functional currency involves measuring the right-of-use asset amortization at the historical exchange rate and the lease liability accretion at the average exchange rate for the applicable period using the guidance under ASC 830-10
, Foreign Currency Matters
Questions have arisen 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 or when the lease is required to be remeasured (see LG 5.2
for lease modification accounting and LG 5.3
for lease remeasurement accounting by a lessee). Based on discussions with the SEC staff, the following approaches are acceptable as an accounting policy choice, which should be disclosed by a lessee:
- Single exchange rate approach: Under this approach, the old lease is essentially “terminated” and a new lease is recognized by remeasuring the entire right-of-use asset using the exchange rate at (1) the lease modification date that is not accounted for as a new lease, or (2) the lease remeasurement date when the lease remeasurement is due to a change in the lease term or change in assessment of exercise of a lessee option to purchase the underlying asset. However, if the remeasurement is due to (a) a change in the amount probable of being owed under a residual value guarantee, or (b) resolution of a contingency that results in variable lease payments becoming fixed, the historical exchange rate should be used to remeasure the entire right-of-use asset.
- Layered approach: Under this approach, a lessee should remeasure only the additional right-of-use asset due to a modification that is not accounted for as a new lease or any type of lease remeasurement using the exchange rate at the modification or remeasurement date.
Example LG 8-1 illustrates application of the two approaches.
EXAMPLE LG 8-1
Remeasurement of right-of-use asset to functional currency
A US dollar functional currency lessee enters into a lease in euros. The lease liability and right-of-use asset is 1,000 euros on the commencement date. At that date, the exchange rate is 1$ = 1 euro, so the lessee records a lease liability and right-of-use asset of $1,000.
At the end of the first reporting period, the exchange rate moves to $1.2 = 1 euro. There are no lease payments in this period. Under ASC 830, at the end of the first reporting period, the lessee remeasures the lease liability to $1,200 (1.2 * 1,000) and recognizes a foreign currency transaction loss of $200 ($1,200 - $1,000) in current period earnings. Since the right-of-use asset is a nonmonetary asset, it is not adjusted under ASC 830 and its functional currency balance remains at $1,000.
At the end of the second reporting period, the exchange rate moves to $1.8 = 1 euro. There are no lease payments in this period. Under ASC 830, at the end of the second reporting period, the lessee remeasures the lease liability to $1,800 (1.8 * 1,000) and recognizes a foreign currency transaction loss of $600 ($1,800 - $1,200) in current period earnings. The right-of-use asset remains at $1,000. Additionally, at the end of the second reporting period, the lessee and the lessor modify the rent payment resulting in an increase in the lease liability from 1,000 to 1,150 euro.
How would the lessee account for the change in lease terms?
Single exchange rate approach
The old lease is essentially terminated and a new lease is recognized. The lessee would remeasure both the right-of-use asset and the lease liability based on the current exchange rate at the end of the second reporting period and record the following journal entry:
Dr. Right-of-use asset
$1,070 (1,150*1.8 - $1,000)
Cr. Lease liability
$270 (1,150*1.8 - $1,800)
Under this approach, in the second reporting period, the lessee (1) records a net foreign currency transaction gain of $200 (difference between $600 loss and $800 gain in that period), and (2) recovers the entire cumulative foreign currency transaction loss that was recognized in the first and second reporting periods (cumulative $800 loss in the first and second reporting periods versus $800 gain in the second reporting period).
The lessee has an existing right-of-use asset of $1,000, which as a nonmonetary asset cannot be remeasured to the current exchange rate. As part of the modification, the lessee has essentially acquired an additional right-of-use asset of 150 euro, which it would remeasure into its functional currency on the modification date. The lessee would make the following journal entry:
Dr. Right-of-use asset
$270 (1.8 * 150)
Cr. Lease liability
$270 (1.8*[1,150 - 1,000])