What is Lease Abandonment?
Lease abandonment occurs when a lessee decides to cease using a right-of-use (ROU) asset before the lease term ends, signaling an impairment indicator unless the asset is subleased, requiring reassessment of the lease term and classification based on changes in circumstances affecting lease options, and differs from lease impairment which involves the asset's carrying amount exceeding its recoverable amount.
What is Lease Abandonment?
An abandoned lease is one where the lessee (the tenant) decides to cease the use of a right-of-use (ROU) asset immediately or at a future date. The decision to abandon an asset is an indicator of impairment for a held and used long-lived asset. When a lessee ceases the use of an ROU Asset but intends to sublease the asset, the asset is not considered abandoned.
When a lessee determines it has or will abandon the ROU Asset, it should reassess the lease term if any of the following conditions exist:
- A significant event or change in circumstances within the control of the lessee that directly affects their reasonable certainty to exercise or not exercise an option to extend or terminate the lease.
- An event is written into the contract that obliges the lessee to exercise or not exercise an option.
- The lessee elects to exercise an option where they previously were not reasonably certain to do so.
- The lessee elects not to exercise an option where they were previously reasonably certain to do so.
If the lease term changes, then the lessee also reassesses the lease classification.
What is the Difference Between Lease Impairment and Abandonment?
A lease impairment occurs when the carrying amount of the asset exceeds its recoverable amount. It is recognized as a reduction of the ROU Asset and a recording of an impairment loss in the financial statements.
Lease abandonment is different because it relates to the lessee's decision to stop using a leased asset before the end of the lease term. Ceasing to use the ROU Asset is an impairment indicator unless the lessee intends to sublease the asset.
How to Account for Lease Abandonment
Example facts and circumstances:
- A 5-year lease term was entered into on 1/1/24.
- Payments are $15,000 per year with a 5% annual increase. Payments are made at the beginning of each year.
- The lessee could not determine the implicit rate in the lease, so they have chosen to use the Incremental Borrowing Rate of 8% as per their policy elections.
- The lease is classified as an Operating Lease.
As of 1/1/24, the beginning balances for the lease are:
- ROU Asset: $70,567
- Lease Liability: $55,567
At the beginning of year 3, the lessee decides they will stop utilizing the asset after the end of Year 3 (12/31/26). They are unable to sublease the asset. This means the asset will be abandoned after year 3, a date known as the cease-use date.
Assume that there is no impairment to the asset group for the ROU Asset and there are no changes to the lease payments or how the lessee will use the asset for Year 3.
At the cease use date, the lessee reduces the ROU Asset to zero with no change to the Lease Liability. The Journal Entry as of the end of Year 3 to write off the ROU Asset is as follows:
- Loss on Abandonment $32,911.31
- ROU Asset $32,911.31
FAQ’s
How are operating lease liabilities recorded on the lessee's balance sheet under ASC 842?
Operating lease liabilities are recorded as short-term and long-term liabilities at the commencement of a lease. They are reduced throughout the lease term.
How to account for abandoned assets
Follow the guidelines set in the example above, ensuring proper documentation of differing variables based on your unique lease agreement, while taking any lease impairments into account as well.