Statutory and GAAP accounting for lease abandonment
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The COVID-19 pandemic has caused insurers to contemplate a number of issues, not least of which is real estate and occupancy costs. Teams of underwriters, claim managers, risk managers, finance professionals and administrators have been working from home since March. In some cases, work from home has been a reality for a longer period—the pandemic has merely accelerated the numbers and the trend. Whatever the case may be, insurers are grappling with unused office space. One question we are hearing is: What if the company decides to abandon its space under an operating lease or significantly reduce the space being used? Should the company continue to account for leased space as normal?
Statement of Statutory Accounting Principles No. 22, Leases provides insurers guidance in this matter. If a lease is terminated before the end of the term, a liability and expense for termination should be recognized. Similarly, if an entity makes a determination that it will cease using leased property, a liability and expense is recognized for the fair value of remaining lease rentals. The liability should be reduced for sublease rentals that can reasonably be obtained even if the entity does not intend to enter a sublease. In subsequent periods the forgone sublease payments would be accreted and recognized in expense.
Insurers that apply GAAP would consider either ASC 840, Leases or 842, Leases. ASC 840 is the present lease accounting guidance which will be superseded by ASC 842. Public companies adopted ASC 842 for fiscal years beginning after December 15, 2018, for most public companies that was January 1, 2019. For private companies, the requirement to apply ASC 842 is effective for fiscal years beginning after December 15, 2021, so January 1, 2022, for calendar year reporting entities.
Accounting under GAAP is the same as statutory if the insurer has an operating lease accounted for under ASC 840. The specific guidance can be found in ASC 420, Exit or Disposal Cost Obligations. Under ASC 842, operating leases result in a right of use asset and a lease liability. In the case of lease termination, the right of use asset and lease liability would be derecognized, and a gain or loss recognized.
An insurer that continues to make lease payments but does not use the leased asset or has abandoned the leased asset would determine whether the leased asset is abandoned and recognize an impairment loss in accordance with ASC 360, Property, Plant and Equipment. If the entity intended to sublease the property, it would continue to derive economic benefit from the right of use asset, however, the asset may be impaired. Impairment losses are determined as the excess of the right of use asset’s carrying value over its fair value.
Below is a summary of the treatment under Statutory and GAAP.