Transcription:

Intro

In this video, we will dive deeper into Lease Accounting Impairments and Abandonments by covering impairment and partial impairments as well as partial abandonment by providing real-world examples.
By the end of this video you will learn:
• What is an impairment and how does it reduce the value of an asset?
• Creating a modified impairment as a future termination (Scenario)
• What are Abandonments – aka – Future Impairments
• And How to create a partial abandonment

Please Take a moment to review the agenda. If you are looking for a specific topic, feel free to jump to the corresponding timestamp.

Advanced Impairments

In this video, you will learn the difference between a full and partial impairment and how it reduces an asset over time.

Before we get started, let’s cover a little bit of background regarding impairments.

Because of the new ASC842 and IFRS 16 standards, all leases must be on a company’s balance sheet. There needs to be a reflection that there is an obligation to pay the rent every month for a predetermined period of time.

A liability is an obligation in the company and an asset is something of value that the company has for its business use.

Because of how double-entry accounting works, if you have a liability on the books, you have to have a corresponding asset, which is the Right of Use Asset.

But what happens when the company no longer has a need for the asset in its business use?
• For example, a Totaled Car
• Or, most likely, a Real Estate asset that is closing a location

If a restaurant chain has a location that is closing, it does not mean the restaurant no longer have to pay rent, but the asset (the restaurant location) doesn’t have any value for the company as a whole any longer. The company will want to do some accounting to move things around for that shuttered location. This is due to the revenue the company generates vs. the cost of generating that revenue, part of which is rent, where analysts can evaluate the health of a company. By continuing to count the rent for the shuttered location, it will make the company not look so healthy.
As result, the company will want to designate that expense as a non-operating expense. An impairment calculation needs to be completed in order to reduce the value of the asset (the shuttered location), and then using other accounting to move the liability into a non-operating account.

To learn more about creating a full impairment, see our VLU video <Lease Accounting: Impairments>

(3:00) To begin, I’ve gone ahead and created a full impairment calculation for this record. When creating the impairment, I set the impairment to be 100% the value of the asset.

On the lease accounting page, you can see there is the initial calculation that was created and also, the impairment of that calculation, which is a type of remeasurement calculation.

After checking the box for the initial calculation and the full impairment, we can see on the lease schedule, the lease payments, here, and the right of use asset is established here. There is also the liability that will be reduced over time. At some point, the impairment is conducted.

The right-of-use asset is written off, bringing the value down to 0. This prevents any further amortization but the liability remains the same since the company is still on the hook for those future payments. But we now show the asset value being reduced to 0 after the impairment.

Since there is no longer an amortization component of the schedule, it will impact the straight line rent. Before the impairment took place, the straight line rent was correct and true, however, after the impairment, the straight line rent will be equal to the interest calculation. The liability will continue to reduce until the lease ends.

You will see in the journal entries associated with the impairment calculation the right-of-use asset is reduced as a credit in the journal entry. However, there is no off-setting liability reduction. Instead, the whole thing is written off at a point in time as a loss on impairment.

The case we just finished is for a full impairment and is not the typical type of impairment. Instead, most companies will need to impair only part of the asset. The calculation needed for partial impairments requires information not saved in Visual Lease and must be done outside of the VL platform. However, Visual Lease can support hypothetical calculations to assist in generating the appropriate values needed for the calculation.

For example, a company sublets a space. Because it is being subleased, the asset is drawing income and has value but it may not be the full carrying cost. As a result, the company will need to know what that sublease income is, how long the space will be empty before the sublease tenant moves in, the cost of moving equipment out, etc…

In visual lease, a company will create a partial impairment as an estimate, to help determine that the lease has to be impaired by a certain amount.

The example can be seen here, where we’ve impaired this asset by $1.5 million . When clicking on the initial calculation and the impairment, you will see that the of use asset amount and we are reducing by $1.5 million dollars which leaves us with $377,606 dollars for the Right of use asset after the impairment is completed.

However, it is important to note: as mentioned before, straight line rent treatment will be lost at the time of the impairment. Instead the amortization will be straight lined every period by adding the interest calculation

The remaining ROU will still need to be amortized down over the remaining term of the lease.

Companies that have impaired a calculation will need to periodically re-evaluate the impairment, typically at the start of the next fiscal year. They will review the impairment to determine of the assumptions made in the impairment were correct. In some cases, further impairment may be needed.

As you can see we impaired this calculation on 5/31/2025. At the end of 2025, we will need to re-evaluate it and realized we will need to impair it for an additional amount of say $100,000.

To complete this, simply run another impairment calculation with a fixed dollar amount and make the effective date one year after first impairment.

Please note: The impairment only remeasures the asset, it does not remeasure the liability.

After the new impairment is completed, the lease schedule will reflect the reduction. We started with $345,772 and now the right of use is showing $242,540. The term has not been shortened, the liability has not been relieved. We have only further written down the asset.

In the journal you will see the impairment amount as a credit for the ROU and a debit of the same amount for Loss on impairment.

It is important to note: According to ASC 842 rules, Once an asset is impaired, it is impaired forever.

Modified Impairment as a Future Termination

In this video we will discuss how to utilize an impairment as a future termination.

Imagine a landlord for a shopping center, and one of the tenants is closing operations and does not have a continuous operation clause in their lease. The tenant can shutter operations but will still have to pay rent until the term is up or a new tenant fills the space.

The problem for the landlord is that the viability of the shopping center is now somewhat reduced since there will be a vacant space. This is because shopping centers have stores that complement each other and draws a certain amount of traffic.

If another tenant rents the space, pays rent, and ultimately helps the health of the shopping center, the landlord will let the original tenant out of the lease. But what if the new tenant will not move into the space until a future date?

This situation will require a future termination of the lease. In order to do this, instead of running a termination calculation, a modification of an impairment is created to reduce the liability down at a specific date which will shorten the term of the lease. This effectively becomes a future termination.

In the schedule, you can see the date of the modified impairment begins, where the ROU asset is reduced and a large chunk of the liability is burned down. In this case, the modified impairment starts on 1/2026 <or whatever date> and you see in the schedule how it reduces everything by 12/2025

In the journal, you will see in the month the term is shortened, there is a gain on the modification, which is essentially the termination action that reduces the long term liability allowing the lease to be brought to an early conclusion.

Abandonments

In this video we will discuss abandonments and how to calculate a partial abandonment.

Before we get started, it is important to define the difference between an Impairment vs. an abandonment.

An impairment means that a company is recognizing the loss of the value of the asset today.

An abandonment recognizes that a company will lose value of the asset in the future. In other words, an abandonment is essentially a future impairment.

To demonstrate. Let’s say a company sets up a lease with an initial value of “33,250” a month and it increased to a certain point in time where the premise is partially abandoned, the payments then split to “$20,000” for part of the lease that will be kept and $16,333 to abandon.

In order to see those results, we must run some calculations in the lease accounting section.

The first thing that needs to be done is to run a modification of the initial calculation to represent the start date in which there will be a partial abandonment.

When looking at the schedule, the payments will reach a point in time where the abandonment takes place. In this case it is the start date of the modification. After the partial abandonment, the lease payment will be $20,000 on the schedule, part of the right of use asset and liability is reduced, The new schedule will continue amortizing for the remainder of the lease term.

The journal entry for this particular entry will show the reduction of the ROU asset and the reduction of the liability. There is no gain or loss associated with this since it was split.

The next step is to create a new abandonment portion with the start date being the same as the modification and the end date at the end of the month. This will create an abandonment schedule 1 month before the premise is actually abandoned.

Next, you will create an abandonment of the abandonment with a decision date (which is the start date) to start the day after the end date of the original abandonment. So in this case, the original abandonment ends on 1/31/23 and the abandonment of the abandonment begins on (2/1/23). Select no for “Asset Previously impaired”. Then select “Loss of Straight Line Lease Cost” in the Go Forward accounting section. A salvage value can be entered for things like vehicles, but since this is real estate, we will leave this blank. The cease use can be a future date (7/31/23).

What happens in the schedule for the abandonment of the abandonment is the amortization is accelerated between the dates of 2/1 and 7/31 so that on 8/1 when the premises is abandoned, there is no more right of use asset. A result of this is a high amortization during the reduction period which causes a high straight-line rent to be displayed. After the abandonment, the straight-line rent will only show the interest calculation.

Key Takeaways

That concludes our course on advanced Impairment and Abandonments in the Visual Lease platform.

We reviewed:
• What an impairment is and how to create a partial impairment
• How to set up an impairment as a future termination
• The difference between Impairments and Abandonments
• And how to create partial abandonments.
Thank you for attending this course – any questions, suggestions or feedback can be sent to support@visuallease.com