Introduction

Welcome to Partial Abandonment Training with VLU. This course is designed to give you a deeper understanding of what a partial abandonment is, when to use it over an impairment and how to one.

By the end of this course, you should be able to:

•  Know the difference between abandonment, impairment, and termination
• When to choose an abandonment vs. an impairment
• And how to split lease data in preparation for the partial abandonment.

Please take a moment to review the agenda. If you’re looking for a specific topic, please jump to the corresponding timestamp.

Abandonment Differences

In this video, we will discuss what an abandonment is and how it is different from a termination and an impairment

Before determining the differences between abandonments and terminations or impairments, we need to define what an abandonment is. In essence, it is when a company is going to cease use of a particular asset either partially or completely.

Two terms are introduced that are not used elsewhere in lease accounting: Decision Date and Cease Use Date.

The decision date is the date on which the entity determines the asset is to be abandoned. This decision necessitates changes in the accounting of the asset. The decision date will be the starting date of the new accounting schedule.

The Cease Use Date is the last day the entity will use the asset. This date is critical, as the Right of Use Asset will be fully amortized by this date, save any residual value.

We should also mention the end date is the end of the contractual obligation. This will remain the original lease expiration date, unless the lease contract is modified.

An abandonment is different from a termination because a termination will relieve the lessee of the obligation for future payments, whereas the abandonment will continue to be obligated to make all future rent payments. The company will not be utilizing the asset though, which means that it no longer has the value that was once recognized. Therefore, the value needs to be removed as an asset from the books.

The difference between an abandonment and an impairment is primarily one of timing. An impairment is a recognition that this asset no longer has value to the organization, so it gets written off. The difference is that an impairment happens today. So if we were to run an impairment with today’s date, the full value of the impairment is written down this month.

An abandonment also removes the value of the right of use asset, but it does so between the decision date and the cease use date.
A partial impairment means that only a portion of the value of the asset is going to be written down, and the rest of the value will remain in place.

For example, a tenant leases two floors of an office building, but now they only want one floor.

The landlord will not relieve the tenant of the obligation to pay, but if they are not going to use one of the two floors, the value of the floor being given up by the tenant needs to be removed, which happens immediately. Essentially, if the tenant impairs an asset today, it will be written off today as well.

The difference between an Abandonment and an Impairment or Partial Impairment in this example, is that an abandonment can remove the value of that unwanted floor between the decision date and cease use date, not immediately like an impairment.

For example, let’s say today is March 1st, and the tenant wants to cease use of one of the two floors they lease on September 1st . The tenant will take the full value of that abandoned floor and write it off over the 6 month period between March 1st and September 1st so that the right of use asset ends up being zero.

Choosing Abandonment vs. Impairment vs. Partial Abandonment

In this video, we will discuss examples of when to choose an abandonment over an impairment or partial abandonment.

Deciding to choose Abandonment versus Impairment has to do with the timing of the event.

As stated in the previous video, an impairment takes place immediately whereas an abandonment can take place in the future, therefore recognizing a future event to take place.

So the question asked is “why not just wait until the lease is abandoned and run an impairment the month it is given up?”. The short answer to this question is that it is not proper accounting. When it is known that the asset will be abandoned, the asset must be written down during the time leading up to the abandonment. Those expenses need to be on the books instead of all of it being accounted for immediately when the asset is abandoned.

It is more appropriate to modify the lease until the abandonment date so the right of use is written off to zero. Doing it in this manner will allow the company to disclose to investors or even the public, of their intentions.

So what about only giving up part of an asset or a partial abandonment?

Before we get into the portfolio approach, it is important to note that technically each identifiable asset should be identified and accounted for separately. For example, leasing 100 cars for a fleet. Each car will be its own leased asset. However, the accounting standards permit us to use the portfolio approach, that is, to treat the group as a single asset, if doing so yields the same results as measuring each asset individually.

When using the portfolio approach, those 100 cars will be grouped together as one entry with all the payments recorded together but are still treated as individual assets.

Please note, if using the portfolio approach, the asset needs to be substantially the same. For example, you can use the portfolio approach with 2 floors of an office building but not one fleet vehicle, one floor of an office building, and a transport ship.

In essence, if the assets were treated as individual leases or treated together as a single lease, the results would be the same. The portfolio approach is typical for companies that lease out facilities.

Splitting Lease Data for Partial Abandonments

In this video, we will discuss how to split lease data in preparation for partial abandonments.

In cases where part of an asset is going to be abandoned, and another part will be retained but they can’t actually be segregated, they will need to be disaggregated and treated as two separate entities before a partial abandonment can take place.

To do this, we will need to split the data in the portfolio.
On the entries page, we can see the lease was originally set up with the initial entries as base rent as seen here. So we are taking 33250 a month and taking 3% increases beyond that.

On the lease accounting page we see that is the methodology we applied and the appropriate payments are continuing throughout remainder of the lease.

Do complete a partial abandonment we will need to split this lease up into two components. Back on the entries page we’ve set up a second component with a portion of the payment which is effective 1/1/2023, located here.

Since we are splitting the payments we will need to modify the initial entry. We will add an unscheduled increase on 1/1/2023, it does not repeat and the base amount will be $20,000 which is the remainder of the amount that wasn’t split off into the other payment.

By inserting that amount you will see that the reduced amount is still increasing by 3% annually and the payments are still on track but now they’ve been split where both payments equal what the original one was.

Once the changes are made, click save.

The next thing that needs to be done is splitting out the lease accounting schedule, creating a different schedule for what is being kept, and what is being abandoned.

Before we move forward with a modification of the initial calculation, you will want to take note of the interest (or discount) rate of the initial calculation. To do this, click “Show More” located here, and scroll down until you see the interest rate, located here.

On the lease accounting page, select the initial calculation that was created and click here. Then select Remeasurement Calculation. In the wizard window, select Modification and enter the effective date of the split.

It is important to note the date we input here, is NOT the date the partial abandonment will take place. This is because we cannot do two things in sequence on the exact same date since the system looks to the date preceding to get opening balances for that particular day.

So for this example, instead of January 1st 2023, we will enter February 1st, 2023.

Move through the wizard and on step 4 you will have to use the same discount rate for both schedules. In this case, it is an 8% incremental borrowing rate.

On step 5 you will see both entries are listed as lease payments. For this calculation, we will want to exclude the payment that we will be abandoning.
Please note, the scheduled amount listed here is the amount from day one of that financial entry, not the amount going into the calculation.

Finish the calculation and click save.

So now we have the modification of the initial calculation. On the schedule we can see the new remaining amount and the right of use asset is somewhat decreased. The schedule now shows the appropriate changes to take what I’m keeping.

The journal entries bring everything down.

For the portion that is being abandoned, we will need to create a NEW calculation, not a modification of an existing calculation.

To start, click on New Calculation, here and the wizard will open. For the calculation name, name it something that will help you identify it. In our case, we will name it Abandonment Portion and use the start date as 1/1/2023 and the same end date.

On step 4, you will want to use the same discount rate that was used in the modification calculation. In our case, it is 8%.

On step 5 you will see both entries are listed as lease payments. For this calculation, we will want to exclude the payment that was kept in the modification and keep the amount we are abandoning.

Save the calculation and return to the lease accounting page.

So now, the two schedules can be seen here; the modified portion of the original schedule, and the abandoned portion. Both of them add up to the amounts from the initial schedule, but now are separated out into two distinct schedules.

We are now ready to perform the actual abandonment calculation.

It is important to note: when creating the split, take care to ensure there is no gain or loss event for the user concerning the right of use asset that is pushed off into the abandonment portion.

To create an abandonment calculation you must create a recalculation of the New “Abandonment” Calculation we just created by clicking here, and selecting Remeasurement calculation.

The popup wizard will open. From the dropdown, select Abandonment. After making the selection, there will be three different dates that need to be entered.

The decision date, which is the date that the new schedule will commence. This is essentially the same thing as a commencement schedule. For this example, our decision date will be 2/1/2023.

Select “No” for Asset Previously Impaired.

For Go Forward Accounting, select “Loss of Straight Line Lease Cost”, which will typically be the case since the asset will be written down in equal amounts over the remainder of the use.

The cease use date is the last date that the occupier is going to be utilizing the premises. For this example, we will enter August 31st, 2023 then click Create remeasurement.

Note: We will discuss Salvage Value later in this video.

On step two it is important to point out that the cease use date we entered is located here, the decision date is also the start date which is seen here. The assumed end date however will reflect the end date of the original value. This is because abandonments do not relieve any future rent payments.

Once everything is entered, click save.

Please note: an abandonment recalculation will not require you to fill out the additional steps in the wizard since there is no discount rate nor change in the payment throughout the remainder of the lease term since an abandonment is not a remeasurement. Everything is based off the original values, but the results will be different.

Checking the Abandonment calculation and scrolling down, you will see on the schedule we will see the part that we are abandoning and what the payments are.

You will also see that the right of use asset if going to amortize in equal steps down over the period of time up until the cease use date that we entered and will be zero from that point forward. The liability continues to burn down over time because payments will continue to be made throughout the life of the lease.

Please note, the results displayed are for a partial abandonment since we split the asset data. For a regular abandonment we would just create the abandonment remeasurement on the entire lease instead of the abandoned portion we just walked through.

So what about salvage values in abandonments?

When creating the abandonment calculation, there is a field to enter a salvage value. A salvage value isnt something typically seen in real estate, but instead with fixed assets. In real estate, salvage will deal with subleases.

For example, a $500,000 lease is abandoned at some point in the future but it is anticipated that there is enough of the lease term left that some income can still be made from it. Therefore, we do not want the asset to burn down completely to zero. Instead, we only want to burn the asset down whatever amount we anticipate, for this example, we think we will get $100,000 in subleased income from the asset. We will only abandon $400,000, leaving that $100,000 income.

A company wants to recognize that they want to have an expense to measure against that sublease income but they do not want to take the expense right up front as if it were an impairment. Doing the abandonment will allow them to properly time the cashflow.

Key Takeaways

This concludes the partial abandonment course with VLU.
Remember…

• Abandonments are meant to write off the right of use asset over time, not immediately.
• For partial abandonments, you will need to split the lease data for what is kept, and what is abandoned
• Salvage Value for real estate allows companies to estimate an amount of subleased income from an abandoned amount.Thanks for watching, any questions, suggestions, or feedback can be sent to Support@visuallease.com