Accounting for Idle Lease/Impairments under ASC 842

At a glance:

• The main takeaway: After nonpublic companies adopted the FASB’s Accounting Standards Codification Topic 842, Leases (“ASC 842”) effective January 1, 2022, accounting for operating leases became more complex as operating leases are now capitalized on the balance sheet.
• The impact on your business: When a situation occurs causing a change in the assumptions and circumstances of the lease currently in place, such as idle lease space, it can have significant blows on the lease asset carrying value, impacting the financial statements and potentially bank covenants.
• Next steps: Changes to leases are frequent in the government contracting world. Aprio’s Government Contracting team can help you stay on top of the accounting and understand their impact. Schedule a consultation today.

Need further guidance on ASC 842? Reach out to Aprio’s Government Contracting specialists today.

The full story:

Has your company transitioned to a hybrid or fully remote workforce and the original lease space is no longer required? Did you win a contract requiring your employees to be on site at a government facility? Under ASC 842, each of these scenarios should trigger an impairment analysis for the associated Right of Use (ROU) Asset. 

Upon implementation of ASC 842 (accounting for leases), the associated Right-of-use (“ROU”) Assets are governed by impairment guidance in ASC 360, Property, Plant, and Equipment. ROU assets must be assessed for impairment at the asset group level. The assessment takes place in three steps:

Step 1: Review for indicators of impairment.

Step 2: Test for recoverability.

Step 3: Measure impairment loss.

Let’s get into each of these steps below.

Step 1

On a regular basis, companies should consider if there have been any changes to the facts and circumstances surrounding their leases, which ultimately could affect the recoverability of the ROU assets’ carrying value. The Financial Accounting Standards Board (FASB) provided certain examples of these within ASC 360-10-35-21:

• “A significant decrease in the market price of a long-lived asset (asset group)
• A significant adverse change in the extent or manner in which a long-lived asset (asset group) is being used or in its physical condition
• A significant adverse change in legal factors or in the business climate that could affect the value of a long-lived asset (asset group), including an adverse action or assessment by a regulator
• An accumulation of costs significantly in excess of the amount originally expected for the acquisition or construction of a long-lived asset (asset group)
• A current-period operating or cash flow loss combined with a history of operating or cash flow losses or a projection or forecast that demonstrates continuing losses associated with the use of a long-lived asset (asset group)
• A current expectation that, more likely than not, a long-lived asset (asset group) will be sold or otherwise disposed of significantly before the end of its previously estimated useful life. The term more likely than not refers to a level of likelihood that is more than 50 percent.”

Step 2

If, through the consideration of Step 1, the Company determines that impairment indicators exist, the ROU asset should be tested for recoverability. This is performed by comparing the carrying amount of the ROU asset to the undiscounted cash flows from its remaining useful life. If the carrying amount exceeds the undiscounted cash flows, the asset’s value is not recoverable.

Step 3

When it is determined that the carrying amount is not recoverable, the ROU asset is impaired and needs to be written down to its fair value. An impairment loss should be recognized.

Right-of-use Asset Impairment – Scenario 1

The Company maintains a floor of office space specifically for a certain government contract. The government client shifts contract requirements, calling for all contractor personnel to work on site at the government agency. No longer requiring the space for its own employees, the Company subleases the space over the remainder of the contract at a loss.

In this situation, the Company would need to perform an impairment analysis because there is a change in the manner of how the ROU asset is being used. This is assuming that the ROU asset is its own asset group because the cash flows generated are directly associated with the government contract it supports, and largely independent of cash flows of other groups of assets and liabilities.

Ultimately, the Company does not need to impair the ROU asset, there are no significant changes in the associated cash flows as the government contract is still intact.

Right-of-use Asset Impairment – Scenario 2

The Company maintains a floor of office space specifically for a certain government contract. The contract unexpectedly comes to an end after year one, and the company no longer requires nor uses the space. As such, the Company subleases the space over the remainder of the contract at a loss.

Again, the Company would need to perform an impairment analysis because there is a change in the manner of how the asset is being used. This is assuming that the ROU asset is its own asset group because the cash flows generated are directly associated with the government contract it supports, and largely independent of cash flows of other groups of assets and liabilities.

As the cash flows associated with this ROU asset (the government contract) went away, and they were not able to break even by subleasing the space, this ROU asset would need to be impaired.

The bottom line:

The implementation of ASC 842 marked a significant change in how entities accounted for their leases, including now having to contemplate if the related ROU assets are impaired.

Aprio’s Government Contracting team can guide you through the various aspects of how to record your lease portfolio under these new guidelines and how it can impact your financial statements. Schedule a consultation with our team today.

For additional discussions regarding leases, please see Accounting for Lease Changes under ASC 842.

Related Resources/Assets/Aprio.com articles/pages

Accounting for Lease Changes under ASC 842

Government Contract Consulting & Advisory Services Page

Government Contracting Insights Page