8.5 Remeasurement of the Lease Liability

ASC 842-20

35-4 After the commencement date, a lessee shall remeasure the lease liability to reflect changes to the lease payments as described in paragraphs 842-10-35-4 through 35-5. A lessee shall recognize the amount of the remeasurement of the lease liability as an adjustment to the right-of-use asset. However, if the carrying amount of the right-of-use asset is reduced to zero, a lessee shall recognize any remaining amount of the remeasurement in profit or loss.

35-5 If there is a remeasurement of the lease liability in accordance with paragraph 842-20-35-4, the lessee shall update the discount rate for the lease at the date of remeasurement on the basis of the remaining lease term and the remaining lease payments unless the remeasurement of the lease liability is the result of one of the following:

A change in the lease term or the assessment of whether the lessee will exercise an option to purchase the underlying asset and the discount rate for the lease already reflects that the lessee has an option to extend or terminate the lease or to purchase the underlying asset.
A change in amounts probable of being owed by the lessee under a residual value guarantee (see paragraph 842-10-35-4(c)(3)).
A change in the lease payments resulting from the resolution of a contingency upon which some or all of the variable lease payments that will be paid over the remainder of the lease term are based (see paragraph 842-10-35-4(b)).

This section addresses phase 5 of the lease “life cycle,” which discusses the guidance that a lessee would evaluate when accounting for the remeasurement of the lease liability.

After the commencement date of the lease, a lessee must remeasure the lease liability if there has been a change to the amounts deemed to be lease payments as described in ASC 842-10-35-4. (See Chapter 6 for additional information on amounts that meet the definition of lease payments, and see Section 8.5.4.4 for considerations related to changes in variable payments based on an index or a rate.) Generally, there will be a change in lease payments when certain discrete reassessment-related events occur or when a lease is modified and that modification is not accounted for as a separate contract.

However, some but not all of these events will necessitate an update to the discount rate used to measure the liability. When a modification is not accounted for as a separate contract, the discount rate must be based on a rate as of the remeasurement date. In addition, if there is a change in the lease term or in the assessment of whether the lessee will exercise a purchase option, the discount rate must be updated (i.e., a rate on the remeasurement date) unless the discount rate already reflects the options to extend or terminate the lease or purchase the underlying asset.

A remeasurement of the lease liability will result in an adjustment to the corresponding ROU asset. In addition, a remeasurement of the lease liability triggers the remeasurement of the consideration in a contract and reallocation of that consideration to the separate components (i.e., a lessee would reallocate the consideration in the contract to all lease and nonlease components).

Certain events that trigger a remeasurement of the lease liability also trigger a reassessment of the lease classification, as noted in Section 8.3.4 and discussed further in this section. Thus, in addition to a change in the lease liability amount, the presentation of this obligation may change (e.g., operating lease liability to finance lease liability or vice versa). In addition to the balance sheet implications, the income statement treatment may also change.

The table below summarizes the topics covered in the remainder of this section.

Changing Lanes

Liability Remeasurement Requirements

The requirement to remeasure the lease liability over the lease term upon the occurrence of certain reassessment events represents a wholesale change to the ASC 840 requirements. For example, under ASC 840, a capital lease liability was only remeasured when the lease is modified. Under ASC 842, the lease liability undoubtedly will be reassessed and remeasured more frequently.

8.5.1 Circumstances in Which a Lessee Is Required to Update Stand-Alone Prices

ASC 842-10-15-33 requires that lessees allocate the consideration in a contract to the lease and nonlease components (and initial direct costs to the separate lease components) on the basis of the relative stand-alone price, as discussed in Section 4.4.1.2.

In accordance with ASC 842-10-15-36, a lessee must remeasure and reallocate the consideration in the contract when there is (1) a remeasurement of the lease liability or (2) a contract modification that is not accounted for as a separate contract (collectively, a “remeasurement event”). (See Section 4.4.1.3 for a discussion of remeasurement and reallocation of consideration in the contract.) Further, as discussed above, ASC 842-20-35-4 specifies criteria for when and how to remeasure a lease liability and ASC 842-10-35-4 contains indicators of when a remeasurement event has occurred (see Section 6.10).

We believe that some may interpret the requirement related to reallocation of “the consideration in the contract” as indicating that the reallocation should be made by using the original allocation percentages identified when ASC 842-10-15-33 is initially applied. Others may interpret the guidance as indicating that an entity should determine new relative stand-alone prices. Accordingly, while the guidance explicitly specifies that the consideration in the contract will be remeasured and reallocated as a result of a remeasurement event, it is not clear on (1) whether, or in which cases, a lessee would need to reevaluate the stand-alone prices of each contract component as of the date of the remeasurement event or (2) whether it would be appropriate to retain the original relative stand-alone prices and thus carry forward the original allocation percentages.

We believe that the requirement for a lessee to revise the relative stand-alone price and related allocation percentages depends on the nature of the remeasurement event. That is, when the remeasurement event is limited to a subsequent-measurement adjustment (e.g., an incremental change in consideration) rather than an event in which the components in the contract are changed (added or subtracted), the lessee would not be required to revise the relative stand-alone price and the related allocation percentages assigned to the components in the contract. In effect, an entity would apply the guidance in ASC 842-10-15-42, which points to the guidance in ASC 606 associated with changes in transaction prices and states that “[i]f the consideration in the contract changes, a lessor shall allocate those changes in accordance with the requirements in paragraphs 606-10-32-42 through 32-45.”

ASC 606-10-32-42 through 32-45 indicate that after contract inception, the transaction price can change for various reasons, such as “resolution of uncertain events or other changes in circumstances that change the amount of consideration to which an entity expects to be entitled” (see Section 7.6 of Deloitte’s Roadmap Revenue Recognition). In these cases, the lessee would reallocate the updated consideration in the contract by using the original relative stand-alone price allocation percentages.

In addition, we believe that when a contract modification is accounted for as a separate contract, the original contract remains in effect and the original stand-alone prices and allocations would also be used. Accordingly, a lessee should first determine whether the remeasurement event results only in a subsequent-measurement adjustment (e.g., a contingency is resolved in such a way that otherwise variable payments become fixed) or another change (e.g., an increase in consideration because the lease was modified to add an additional lease component and a related nonlease component).

Therefore, in an evaluation of the lessee remeasurement guidance in ASC 842-10-35-4 (see Section 6.10), if the following events outlined in ASC 842-10-35-4(b) and ASC 842-10-35-4(c)(3) occur in isolation, the lessee would not update the stand-alone prices or relative stand-alone price allocation and updates to the consideration in the contract would be allocated on the original basis:

A lessee shall remeasure the lease payments if any of the following occur: . . .

b. A contingency upon which some or all of the variable lease payments that will be paid over the remainder of the lease term are based is resolved such that those payments now meet the definition of lease payments. For example, an event occurs that results in variable lease payments that were linked to the performance or use of the underlying asset becoming fixed payments for the remainder of the lease term. . . .

c. There is a change in any of the following: . . .

3. Amounts probable of being owed by the lessee under residual value guarantees. A lessee shall determine the revised lease payments to reflect the change in amounts probable of being owed by the lessee under residual value guarantees.

However, when any other condition in ASC 842-10-35-4 is met in isolation (e.g., a contract modification that is not accounted for as a separate contract) or in any instance in which the above guidance is combined with another condition in ASC 842-10-35-4, updated standalone prices should be established and consideration should be reallocated to the updated components. This stipulation generally is consistent with the view that when additional components (including extending the term of the contract) are added to (or subtracted from) the contract, new stand-alone prices should be established in connection with the remeasurement event. As a result, new estimates of stand-alone prices and reallocation would be required when the following remeasurement events outlined in ASC 842-10-35-4(a) and ASC 842-10-35-4(c)(1) and (c)(2) occur:

a. The lease is modified, and that modification is not accounted for as a separate contract in accordance with paragraph 842-10-25-8. . . .

c. There is a change in any of the following:

1. The lease term, as described in paragraph 842-10-35-1. A lessee shall determine the revised lease payments on the basis of the revised lease term.

2. The assessment of whether the lessee is reasonably certain to exercise or not to exercise an option to purchase the underlying asset, as described in paragraph 842-10-35-1. A lessee shall determine the revised lease payments to reflect the change in the assessment of the purchase option.

When a contract modification is accounted for as a contract that is separate from the original contract in accordance with ASC 842-10-25-8 (see Section 8.6.2), the stand-alone price of each contract component in the new contract would always need to be assessed, since the new contract is disassociated with the existing agreement at the time of the modification.

8.5.2 Change in the Lease Term or in the Conclusion About the Exercise of a Purchase Option

ASC 842-20

35-5 If there is a remeasurement of the lease liability [as a result of a change in lease payments], the lessee shall update the discount rate for the lease at the date of remeasurement on the basis of the remaining lease term and the remaining lease payments unless the remeasurement of the lease liability is the result of one of the following:

A change in the lease term or the assessment of whether the lessee will exercise an option to purchase the underlying asset and the discount rate for the lease already reflects that the lessee has an option to extend or terminate the lease or to purchase the underlying asset. . . .

8.5.2.1 Timing of Reassessment Related to Lease Term and Purchase Option

ASC 842-10-35-1 indicates that, upon the occurrence of certain discrete events, a lessee is required to reassess its conclusion about the lease term and the likelihood that it will exercise an option to purchase the underlying asset. See Section 5.4 for additional information.

As described below, when a lessee changes its conclusion about whether it will exercise a renewal, termination, or purchase option, it would generally (1) reassess lease classification in considering the facts and circumstances that exist as of the reassessment date, (2) remeasure the lease liability by using revised inputs as of the reassessment date, and (3) adjust the ROU asset. However, in certain circumstances, a lessee would not update its discount rate, such as when the discount rate already reflects the option.

8.5.2.2 Accounting for the Reassessment of the Lease Term and Purchase Option

If, as a result of a reassessment event, a lessee determines that the lease term has changed or changes its conclusion regarding whether it is reasonably certain that it will be exercising a purchase option, the lessee would update its lease payments to reflect the change and remeasure its lease liability. In remeasuring the lease liability, the lessee should remeasure variable lease payments based on an index or a rate by using the index or rate on the remeasurement date.

As shown in the graphic above, the lessee is required to do the following on the remeasurement date in the circumstances described above:

Remeasure and reallocate the consideration in the contract to the remaining lease and nonlease components (see Chapter 4).
Remeasure the lease liability on the basis of the revised lease payments and updated discount rate, if applicable (see Section 6.10). The discount rate is updated by using the assumptions on the remeasurement date unless the discount rate in use (i.e., the discount rate as of the last lease commencement date) already reflects the option to extend or terminate the lease or purchase the underlying asset, in which case the discount rate in use continues to be employed (see Section 7.2.2).
Adjust the ROU asset by the amount of the remeasurement of the lease liability. When the lease liability is reduced as the result of the remeasurement, the ROU asset would similarly be reduced. Note that the carrying amount of the ROU asset cannot be reduced below zero and any amounts in excess of the ROU asset balance are recognized in net income.
Reassess lease classification as of the reassessment date on the basis of the facts and circumstances on that date. For example, the lessee should reassess classification on the basis of the fair value and remaining economic life of the underlying asset on the remeasurement date (see Section 8.3.4).
If the classification of the lease changes as a result of the reassessment event, a lessee will prospectively adjust the remaining lease cost recognition pattern and update the income statement and cash flow statement presentation.

See Example 3 (ASC 842-20-55-31 through 55-39, reproduced in Section 8.9.1.1) for an illustration of the accounting for a change in the lease term caused by a change in a lessee’s conclusion about whether it will exercise a renewal option.

8.5.3 Change in the Amount That It Is Probable a Lessee Will Owe at the End of the Lease Term Under a Residual Value Guarantee

ASC 842-20

35-5 If there is a remeasurement of the lease liability [due to a change in lease payments], the lessee shall update the discount rate for the lease at the date of remeasurement on the basis of the remaining lease term and the remaining lease payments unless the remeasurement of the lease liability is the result of one of the following: . . .

b. A change in amounts probable of being owed by the lessee under a residual value guarantee (see paragraph 842-10-35-4(c)(3)). . . .

8.5.3.1 Continual Reassessment of the Amount That It Is Probable a Lessee Will Owe Under a Residual Value Guarantee

A lessee must continually evaluate the amount that it is probable the lessee will owe at the end of the lease term under a residual value guarantee. Any change in this amount is a reassessment event that would result in the remeasurement of the lease liability. See Section 6.7 for additional information.

8.5.3.2 Accounting for Changes in the Amount That It Is Probable a Lessee Will Owe Under a Residual Value Guarantee

When there is a change in the amount that it is probable the lessee will owe under a residual value guarantee, the lessee must remeasure its lease liability to reflect the change. In remeasuring the lease liability, the lessee should remeasure variable lease payments based on an index or a rate by using the index or rate on the remeasurement date.

As shown in the graphic above, the lessee is required to do the following on the remeasurement date in the circumstances described above:

Remeasure and reallocate the consideration in the contract to the remaining lease and nonlease components (see Chapter 4).
Remeasure the lease liability on the basis of the revised lease payments (see Section 6.10) by using the original discount rate that was used on the lease commencement date (see Section 7.2.2).
Adjust the ROU asset by the amount of the remeasurement of the lease liability. Note that the carrying amount of the ROU asset cannot be reduced below zero and any amounts in excess of the ROU asset balance are recognized in net income.

When the lease liability is remeasured to reflect the change in amounts that it is probable the lessee will owe under a residual value guarantee, the lessee does not reassess lease classification.

Changing Lanes

Residual Value Guarantees

Under ASC 840, the accounting for residual value guarantees from the lessee’s perspective depended on the lease’s classification. For an operating lease, amounts expected to be payable under a residual value guarantee were accrued for separately on the balance sheet. In contrast, for a capital lease, the full amount of the residual value guarantee was used to determine, and accounted for as part of, the capital lease obligation and related asset. Under ASC 842, the amount that it is probable a lessee will owe at the end of the lease term under a residual value guarantee is considered a lease payment and used to determine the lease liability for both operating and finance leases. Depending on the type of asset and the circumstances of the lease, the amount that it is probable the lessee will owe could be significantly less than the full guaranteed amount.

8.5.4 Variable Payments Become Lease Payments Because of the Resolution of a Contingency

ASC 842-20

c. A change in the lease payments resulting from the resolution of a contingency upon which some or all of the variable lease payments that will be paid over the remainder of the lease term are based (see paragraph 842-10-35-4(b)).

8.5.4.1 Continual Reassessment of Whether Lease Payments Change Because of a Contingency Resolution

A lessee must continually evaluate the nature of its variable lease payments to determine whether the variable payments at some point become fixed and would therefore meet the definition of lease payments. When a contingency by which some (e.g., payments pertaining to years 3–9 of a remaining 10-year lease term) or all (e.g., payments pertaining to all years remaining in the lease term) of the variable payments that will be paid over the remainder of the lease term has been resolved in such a way that the payments become fixed and now meet the definition of lease payments, a lessee must remeasure its lease liability to reflect this change.

8.5.4.2 Accounting for a Change in Lease Payments Resulting From the Resolution of a Contingency

When there is a resolution of a contingency that causes some or all of the variable payments to now meet the definition of lease payments (e.g., to become fixed for the remainder of the lease term), a lessee must remeasure its lease liability to reflect the change. In remeasuring the lease liability, the lessee should remeasure other variable lease payments that are based on an index or a rate by using the index or rate on the remeasurement date.

As shown in the graphic above, the lessee would be required to do the following on the remeasurement date in the circumstances described above:

Remeasure and reallocate the consideration in the contract to the remaining lease and nonlease components (see Chapter 4).
Remeasure the lease liability on the basis of the revised lease payments (see Section 6.10) by using the original discount rate used at the lease commencement date (see Section 7.2.2).
Adjust the ROU asset by the amount of the remeasurement of the lease liability. Note that the carrying amount of the ROU asset cannot be reduced below zero and any amounts in excess of the ROU asset balance are recognized in net income.

When the lease liability is remeasured to reflect a change in lease payments because of the resolution of a contingency, the lessee does not reassess lease classification.

8.5.4.3 Accounting for Lease Incentives Not Paid or Payable at Commencement

A lessor sometimes provides a lessee with a lease incentive to entice the lessee into leasing the underlying asset (e.g., the lessor may provide the lessee with funding for the construction of certain lessee-specific leasehold improvements). Lease incentives are a component of lease payments, which, as described in ASC 842-10-30-5(a), include “[f]ixed payments, including in substance fixed payments, less any lease incentives paid or payable to the lessee” (emphasis added). ASC 842 is also explicit that lease incentives that are received by the lessee on or before the lease commencement date would be accounted for as a reduction of the ROU asset in accordance with ASC 842-20-30-5.

While the guidance is clear on the accounting for incentives received on or before the lease commencement date, it is not clear on how a lessee should account for incentives that are included in the original lease contract but received after lease commencement (e.g., incentives paid to the lessee upon the completion of a certain activity, such as completion of construction of leasehold improvements after lease commencement). See Section 6.2.2 for more information on the definition of a lease incentive in ASC 842. In addition, see Section 6.2.2.2 for considerations related to incentive payments a lessor makes to a lessee after lease commencement.

While ASC 842 is silent on how a lessee should account for lease incentives that are only receivable after a future event (other than the passage of time) expected to occur after the lease commencement date, we believe that a lessee could use the following two-step approach:14

Step 1: Evaluate whether it is appropriate to estimate the incentive at lease commencement — We believe that it would be appropriate for the lessee, on the lease commencement date, to estimate and include in its lease payments any lease incentive amounts based on future events when (1) the events are within the lessee’s control (e.g., construction of the leasehold improvements) and (2) the event triggering the right to receive the incentive is deemed reasonably certain to occur.

If some or all of a recognized incentive is not ultimately received (i.e., the lessee does not become entitled to the incentives) or the amounts received are greater than the amounts previously estimated (i.e., the lessee becomes entitled to additional incentives not previously estimated), the change would be accounted for as a change in lease payments in a manner similar to the accounting described in step 2 below.
Step 2: Account for the incentive amounts triggered after lease commencement and received that were not previously recognized (or that were different from the amount recognized at commencement) as a change in lease payments — Any lease incentives that are received or become receivable after lease commencement and were not recognized at lease commencement or that differ from the amount recognized at lease commencement (i.e., by applying step 1) would result in the remeasurement of the lease payments once the triggering event occurs that provides the lessee with the right to the incentive. This view is by analogy to ASC 842-10-35-4(b), in which lease payments must be remeasured when a “contingency upon which some or all of the variable lease payments that will be paid over the remainder of the lease term are based is resolved such that those payments now meet the definition of lease payments.”

If the lease incentive received is greater than the amount recognized at lease commencement (or if no amount was recognized at lease commencement), this difference should be recognized as an adjustment (reduction) to the ROU asset. If the lease incentive received is less than the amount recognized at lease commencement, the difference (amount by which the original lease liability was adjusted but that is no longer expected to be received) would result in an adjustment to the lease liability (an increase in the liability) and a corresponding adjustment to the ROU asset. Further, under ASC 842-20-35-5(c), when remeasuring its lease liability, the lessee would not reassess lease classification or use an updated discount rate (i.e., the lessee would continue to use the discount rate that was used at lease commencement).

8.5.4.4 Implications of Index- or Rate-Based Payment Adjustments

Index- or rate-based payment adjustments that establish a new floor do not represent a resolution of a contingency that would result in a change in lease payments and would therefore not result in a liability remeasurement event.

This is consistent with the guidance in ASC 842-10-35-4(b), which was added by the Codification improvements in ASU 2018-10 and states, in part:

However, a change in a reference index or a rate upon which some or all of the variable lease payments in the contract are based does not constitute the resolution of a contingency subject to (b) (see paragraph 842-10-35-5 for guidance on the remeasurement of variable lease payments that depend on an index or a rate). [Emphasis added]

On the basis of this technical amendment, the guidance on remeasuring a lease liability after the resolution of a contingency is not meant to apply to index-based escalators even when those escalators serve to establish a new floor for the next lease payment. Therefore, even when the index or rate establishes a new floor (such as when the CPI increases and establishes a new rate that will be used as a benchmark for determining future lease payment increases), that adjustment would not result in a remeasurement of the lease liability and ROU asset. As a result, the additional payments for increases in the CPI will be recognized in the period in which they are incurred.

See Section 17.3.1.3 for additional information on other updates made by ASU 2018-10.

8.5.4.5 Impact of Cotenancy Clauses on Determining Lease Payments

Certain real estate leases may include a provision that would result in a decrease in the specified lease payments when there are specific changes to the occupancy structure in the broader real estate interest. For example, retail leases often include a cotenancy clause under which there will be a specified reduction in the required lease payments if an anchor tenant vacates or if the overall occupancy of the mall drops below a certain level.

At lease commencement, the lessee would recognize a lease liability and ROU asset on the basis of amounts meeting the definition of lease payments as of the commencement date. This would exclude any amount associated with the variability that may result from the triggering of a cotenancy clause, since this clause is designed to be protective for the lessee and would not affect the payment terms until a triggering event occurs.

When facts and circumstances change or an event occurs that results in the triggering of a cotenancy clause in a real estate lease, we believe that it would be appropriate to apply one of the two approaches below to the subsequent accounting.

Approach 1: Cotenancy clause results in negative rent — Any change in facts and circumstances that results in the triggering of a cotenancy clause would not be considered a lease payment remeasurement event that would affect the lease liability and ROU asset. Therefore, rebates resulting from the triggering of a cotenancy clause would be treated as a variable lease payment (though a negative variable lease payment) not based on an index or rate. As a result, the lessee would recognize the difference between the periodic lease cost determined at lease commencement and the revised payments due to the cotenancy clause as variable rent (albeit negative rent) in the applicable period.
Approach 2: Cotenancy results in the resolution of a contingency and is a lease payment reassessment event — Any change in facts and circumstances that results in the triggering of the cotenancy clause would be considered a lease payment remeasurement event that would affect the lease liability and ROU asset. Thus, the lease liability and ROU asset would be remeasured to reflect the revised lease payment amounts through the end of the lease term. If the cotenancy issue is later resolved in such a way that the lease payments return to their original amounts, such resolution is another remeasurement event. Therefore, under this approach, the lease liability and ROU asset will continually be reassessed upon changes in facts and circumstances that result in the triggering of the cotenancy clause and the subsequent resolution of the condition that led to the triggering of the clause.

Some view this approach as consistent with the guidance in ASC 842-10-35-4(b). That is, the triggering of the cotenancy clause would be a resolution of a contingency in such a way that there is a change in some or all of the lease payments for the remainder of the lease term. While ASC 842-10-35-4(b) focuses on variable payments that subsequently become fixed and does not specifically describe fixed payments in an arrangement that subsequently become variable (or a lower fixed amount), we believe that it would be appropriate to apply such guidance by analogy.

Footnotes

The discount rate would not be updated in a scenario in which a change in lease term or the exercise of a purchase option was already reflected in the discount rate determination but the exercise of the option itself was not deemed reasonably certain at lease commencement.

In addition, we believe that there may be other acceptable approaches, including an election to move directly to step 2 rather than estimating the lease incentive as of the commencement date.

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.