Accounting and valuation considerations
Companies that have adopted the new leases standard (ASC 842) may want to coordinate the rationalization of their leased real estate footprint with accounting and valuation analyses to aid in big-picture decision-making.
In some cases, companies may plan to abandon or sublease certain locations or discrete components of locations (such as separate office buildings or floors), triggering impairment analyses of the underlying right-of-use (ROU) assets. In other cases, a company may intend to remain in its leased space through expiration but have reason to believe the underlying market value of the asset has been permanently impacted. In either scenario, management should consider the following key questions:
- What is the remaining term of the existing arrangement and does it include or exclude any renewal or termination options?
- Do you anticipate receiving any rent concessions, deferrals or renegotiating other aspects of the arrangement?
- Has management committed to a plan to sublease or abandon the space?
- Does the company have the right to sublease space?
- If subleased, would the company still be the primary tenant or would the sublessee “take over” the obligation?
- When would the company be able to exit the premises and remove any remaining assets or inventory from spaces it intends to sublease or abandon?
- What market data is available for prime and sublease positions in the area?
- How long are similar spaces taking to find new tenants?
Companies should also proactively work with their valuation advisors, accounting departments, advisors and auditors to develop their own strategic alternatives and to consider a market-participant point of view.
Depending on the answers above, numerous accounting implications may exist, including how management decisions may apply to separate lease components, when leased premises may be considered abandoned and whether sublease arrangements are treated as a termination of the prime lease. They could also affect the timing and amount of impairments recognized.
Coordinating these practical, financial, accounting and valuation considerations around leased assets can help companies understand the implications of their leasing decisions and aid in a stakeholder communication strategy that is clear and comprehensive. While the long-term impact of diminished office usage is still uncertain, it’s clear that companies may need to start thinking about potential income statement and balance sheet impacts now.