Renewal Options

Background

When a lessee records the lease liability and right-of-use asset during the transition to ASC 842, renewals and extensions need to be considered. 

US GAAP 842-10-30-1 in part reads, "An entity shall determine the lease term as the noncancellable period of the lease, together with all of the following: a. Periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option..." If a lease contract outlines renewals or extensions then those periods should be added to NetLease at transition if the options are "reasonably certain" to be exercised.

Application

For example, consider a lease that began on 1/1/2019 with an end date of 12/31/2023. That lease also contains two options to extend the lease for five years each. If the lessee intends to exercise both of those options, this lease should be entered with a lease term that ends on 12/31/2033.

In another example, a lease has the same terms as above. This time, the lessee may or may not exercise the options to extend. Since the options are not "reasonably certain" to be exercised, the lease will be entered with an end date of 12/31/2023. If the lessee and lessor later agree to the extension as the original end date comes near, then the lease will be remeasured at that point. Let's say that on 9/30/2023, the first five-year extension is exercised. On 9/30/2023, the lessee will change the end date to 12/31/2028 through a lease modification.