Lease Termination Accounting: Costs and Options to Terminate

There is a chance that entities may have hidden leases in services contracts which have not been captured previously as the costs would be expenses as incurred, as with the current operating lease treatment. In the third of our 2025 Audit and Accounting updates we explore how the latest updates to the Financial Reporting Standards affect lease accounting in the financial statements. Our thorough investigation has shown in our clear findings the several benefits and drawbacks of leasing rather than purchasing corporate equipment. The choice depends on a careful juggling of operational continuity, long-term cost-effectiveness, cash flow management, and strategic alignment with corporate goals.

• Here, the direct ownership concept fits the strategic emphasis of the company on operational stability and long-term cost control.
• He holds a Bachelor’s degree in Engineering and is an avid high-altitude mountaineer, having climbed peaks across the Himalayas, Africa, and Europe.
• The ‘right-of-use’ asset should also be reviewed for possible impairment each year, this effectively replacing the consideration of onerous leases.
• If you’re a small business reporting under FASB or IASB standards, LeaseGuru powered by LeaseQuery might be the right lease accounting solution for you.
• If a lease termination penalty is applicable and not previously included in the calculation of lease payments, the lessee will factor such penalty into the gain or loss calculation.

Understanding lease termination events

In the long term, buying could be more affordable for assets with solid technology and long operational lifetime. Leasing equipment is a decision taken by a service-based organization depending on contemporary IT architecture. This allows the business to keep improving its technology, therefore guaranteeing that staff members have access to modern tools without appreciable interference with cash flow. The lease agreement covers thorough maintenance and support, therefore enabling the company to focus on service delivery rather than equipment administration. An entity may choose not to reassess whether contracts that exist at the date of initial application are, or contain, leases. Instead, Law Firm Accounts Receivable Management the new lease accounting requirements are applied to contracts that were previously identified as containing a lease and not applied to contracts that were not previously identified as containing a lease.

IFRS

However, with the most recent amendments set to take effect on January 1, 2026, the distinction between the two is largely removed for lessees. Now, most lease agreements will require recognition of a right-of-use (ROU) asset and a lease liability on the balance sheet. Under ASC 842 lease terminations occur when a lessee or lessor ends a lease before the original lease term expires. Partial lease terminations, in particular, involve terminating only a portion of the leased asset, while the remaining portion continues to be leased.

End-of-Term Options

When a lease involves both land and buildings, the lessor should independently evaluate the classification of each component as either a finance lease or an operating lease. Lease payments must be allocated between the land and buildings components, reflecting the relative fair values of the leasehold interests in the land and buildings at the inception of the lease. Like IFRS 16, a lessor in a sales-type or direct financing lease accounts for a lease modification as a separate contract if the same criteria used by lessees to make this assessment are met. If the original lease is a finance lease, the lessor needs to assess whether the modification creates a separate lease using the same criteria as lessees.

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• At the beginning of Year 6, LE and LR agree to amend the contract to grant LE the right to use an additional floor of office space in the same building for 5 years.
• To reduce these dangers, one must carefully go over the leasing agreement including legal provisions and service assurances.
• Consequently, it’s implausible that the lease term will cover the majority of the economic life of the underlying land.
• This process ensures that financial statements accurately reflect the company’s obligations and assets post-termination.
• Determining the length of the lease will be important for the appropriate accounting, as the lease term will take into consideration options to extend or terminate leases where these are ‘reasonably certain’ to be exercised.
• However, differences in the accounting for a lease both pre- and post-modification arise because of the differences between the single IFRS 16 and dual US GAAP lessee accounting models.

Once you have viewed this piece of content, to ensure you can access the content most relevant to you, please confirm your territory. Join our experts for practical insights on the key changes to UK and recording transactions Ireland’s Financial Reporting Standards. We will continue looking at individual key changes in more depth throughout 2025 with further articles and in person events designed for finance professionals.