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Modification and remeasurement of a lease

Terminating the lease of one asset before the end of the lease term and leasing a similar asset from the
same lessor may not always be considered a full termination of the original lease. In some cases, it may
be treated as a modification. For example, if a lessee negotiates to terminate a lease of one floor of a
building and concurrently negotiates a new lease of a different floor in the same building, this would
be accounted for as a modification if the new lease was not priced at market. This is an important
distinction to make because the accounting can vary significantly. A lease termination results in a gain
or loss charged to the income statement immediately. A modification does not result in an immediate
charge to the income statement, unless the modification is a considered a partial termination (see LG
5.5.1). In that case, there would be some impact to the income statement. However, the income
statement impact will not be the same as it would be for a full lease termination.

5.5.1 Accounting for a partial lease termination

A modification or reassessment of a lease may result in a partial termination of the lease. Examples of
events that result in a partial termination include terminating the right to use one or more underlying
assets and decreasing the leased space. A decrease in lease term is not considered a partial termination
event. A partial termination should be recorded by adjusting the lease liability and right-of-use asset.
The right-of-use asset should be decreased on a basis proportionate to the partial termination of the
existing lease. The difference between the decrease in the carrying amount of the lease liability
resulting from the modification and the proportionate decrease in the carrying amount of the right-of-
use asset should be recorded in the income statement.

There are two ways to determine the proportionate reduction in the right-of-use asset. It can be based
on either the reduction to the right-of-use asset or on the reduction to the lease liability. For example,
if a lessee decreases the amount of space it is leasing in an office building by 45% and as a result, the
lease liability decreases by 50%, the right-of-use asset could be decreased by either 45% or 50%. See
Example 18 beginning at ASC 842-10-55-177 for an example of lessee accounting for a partial lease
termination.

A lessee should treat its selected method as an accounting policy election by class of underlying asset.
The policy should be applied consistently to all modifications that decrease the scope of a lease.

5.5.2 Purchase of a leased asset during the lease term

A lessee’s accounting for the purchase of an underlying asset is described in ASC 842-20-40-2.

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.

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