8.7 Derecognizing a Lease
8.7.1 Setting the Stage
This section addresses phase 7 of the lease
“life cycle,” which discusses the guidance that a lessee would evaluate when
determining how it will derecognize a lease.
8.7.2 Lease Termination
ASC 842-20
40-1 A termination of a lease before the expiration of the lease term shall be accounted for by the lessee by removing the right-of-use asset and the lease liability, with profit or loss recognized for the difference.
When a lease is fully terminated before the expiration of the lease term,
irrespective of whether the lease is classified as a finance lease or an
operating lease, the lessee would derecognize the ROU asset and corresponding
lease liability. Any difference would be recognized as a gain or loss related to
the termination of the lease. Similarly, if a lessee is required to make any
payments or receives any consideration when terminating the lease, it would
include such amounts in the determination of the gain or loss upon
termination.
When a lease is partially22 terminated before the expiration of the lease term, the lessee would
account for the partial termination as a lease modification (see Section 8.6.3.7 for more
information). If a lessee is required to make any payments or receives any
consideration when terminating the lease, it would include such amounts in the
determination of the revised consideration in the modified contract (see
Section 8.6.3.7.1 for more information).
8.7.3 Purchase of the Underlying Asset
ASC 842-20
40-2 The termination of a lease that results from the purchase of an underlying asset by the lessee is not the type of termination of a lease contemplated by paragraph 842-20-40-1 but, rather, is an integral part of the purchase of the underlying asset. If the lessee purchases the underlying asset, any difference between the purchase price and the carrying amount of the lease liability immediately before the purchase shall be recorded by the lessee as an adjustment of the carrying amount of the asset. However, this paragraph does not apply to underlying assets acquired in a business combination, which are initially measured at fair value in accordance with paragraph 805-20-30-1.
The lessee’s purchase of the underlying asset is not a lease termination under ASC 842-20-40-1. Rather, when a lessee purchases the underlying asset, it would reclassify the ROU asset balance and adjust the carrying value of the purchased asset by the difference between the purchase price of the asset and the lease liability immediately before the purchase.
Underlying assets that are acquired as part of a business combination are not subject to the accounting
guidance in ASC 842-20-40-2. Rather, these assets would be initially measured at fair value in
accordance with ASC 805.
8.7.4 Subleasing When Original Lessee Is Relieved of Primary Obligation
ASC 842-20
40-3 If the nature of a sublease is such that the original lessee is relieved of the primary obligation under
the original lease, the transaction shall be considered a termination of the original lease. Paragraph 842-20-
35-14 addresses subleases in which the original lessee is not relieved of the primary obligation under the
original lease. Any consideration paid or received upon termination that was not already included in the lease
payments (for example, a termination payment that was not included in the lease payments based on the lease
term) shall be included in the determination of profit or loss to be recognized in accordance with paragraph
842-20-40-1. If a sublease is a termination of the original lease and the original lessee is secondarily liable, the
guarantee obligation shall be recognized by the lessee in accordance with paragraph 405-20-40-2.
Under ASC 842, a head lessee that enters into a sublease with another party must consider whether
(1) it has subleased the asset to the other party or (2) it has extinguished its head lease as a result of its
arrangement with the other party. This determination is governed by whether the lessee is relieved of
its primary obligation under the head lease, as described in ASC 842-20-40-3. Scenarios in which a head
lessee subleases the asset to another party are addressed in Section 12.3.
In a sublease scenario, when the intermediate lessor is relieved of its obligations under the head lease
(i.e., the original lease that a lessee has with a third-party lessor), the transaction would be considered a
termination of the head lease. In a manner consistent with the discussion in Section 12.3.2, the lessee/
intermediate lessor would derecognize the ROU asset and lease liability arising from the head lease
and would recognize any difference in profit or loss. Any additional consideration received or paid on
termination that was not already included in the lease payments would generally be included in the
calculation of the gain or loss resulting from the termination (e.g., a termination penalty not included in
the determination of the original lease liability).
When a sublease results in the termination of the original head lease and the original lessee remains
secondarily liable in the lease agreement, the lessee would recognize a guarantee obligation in
accordance with ASC 405. Specifically, ASC 405-20-40-2 states that “in those circumstances, whether or
not explicit consideration was paid for that guarantee, the original debtor becomes a guarantor.” As a
result, the guarantee obligation would be measured at fair value, with an offsetting adjustment to the
gain or loss recognized on terminating the lease.
In each scenario in which an intermediate lessor is relieved of its primary obligation under the original
head lease, the intermediate lessor would not be subject to sublease accounting. See Chapter 12 for
additional information about subleases.
Footnotes
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A partial termination occurs when the parties in an
existing lease agree to terminate the lessee’s right to use (1) some of
the assets under the lease (e.g., discrete pieces of equipment) or (2) a
portion of an asset (e.g., one of several leased floors in an office
building).