Congratulations, you are a lessee accounting for leases under the new ASC 842 or IFRS 16 standard! You identify a lease that has a lease term of 12 months or less and does not include a reasonably certain purchase option. You may elect to account for such leases as short-term leases (see our post on Short-term lease exemption to help determine if you should make this election). This election is made by class of underlying asset.
In addition to the short-term lease exemption, IFRS 16 also allows for a low-value lease exemption. Low-value leases are accounted for in the same manner as the short-term lease exemption, however, it can be made on a lease-by-lease basis when:
The lease is assessed on the value of the underlying asset when the asset is new. The assessment does not factor in the materiality or size of the organization, but rather all organizations should reach the same conclusion about whether the lease is classified as low value. There is no defined amount in the standard for the low-value distinction, but the general rule is $5,000 and below.
The lessee must benefit from the use of the underlying asset on its own or together with other readily available resources to qualify as low value.
The underlying asset cannot be highly dependent on, or highly interrelated with, other assets to qualify as low value.
The head lease of subleased items (or anticipated subleased items) can not apply the low-value exemption.
Accounting Implications of the Election
The short-term and low-value lease elections allow companies to recognize lease payments as an expense on the income statement with any differences between the payment and lease expense recorded to the balance sheet as deferred rent.
This treatment differs from the standard lease accounting in which an ROU asset and lease liability are recorded on the balance sheet. The short-term/low-value election accounting treatment is the same as operating leases under the old leasing standard (ASC 840). For more information on deferred rent under ASC 840 and ASC 842, see our article “What Happened to Deferred Rent?”.
For leases classified as 'short-term' or ‘low-value’, any time there is a difference in a lease cash payment and lease expense, companies will accrue for deferred rent. Under ASC 842, deferred rent will only be applicable for short-term or low-value leases. In order for a short-term or low-value lease to have deferred rent it needs to have one of the following criteria: 1) prepaid lease payments, 2) lease incentives, 3) initial direct costs, 4) rent escalations, 5) rent abatements.
Example: Without Deferred Rent
You have a $500 monthly lease for an office copy machine. The commencement date is November 1, 2022, with a term of 12 months. You determine the lease to be short-term and elect to use the short-term lease exemption.
In this example, the lease payment and lease expense are the same each month and no liability (deferred rent) will be recorded.
Example: With Deferred Rent
You have a $500 monthly lease for an office copy machine. The commencement date is November 1, 2022, with a term of 12 months. You determine the lease to be short-term and elect to use the short-term lease exemption. Additionally, you have a prepayment of $250 and no payment is required in the first month.
In this example, the rent abatement and the prepayment cause the lease payment and lease expense to be different every month. As such, a liability (deferred rent) will be recorded.
Should you elect to use the short-term or low-value lease exemptions, you are required to disclose the following information:
Short-Term Lease Exemption Disclosures
Low-Value Lease Exemption Disclosures
Disclose the fact that you are using short-term lease accounting and to which asset classes it applies.
Disclose the fact that you are using low-value lease accounting.
Disclose the undiscounted amount of the short-term lease commitment—if significantly different from the amount reported.
Disclose the lease costs of applicable leases—can exclude expenses for leases with a term of one month or less.
Disclose the lease costs of applicable leases—can exclude expenses for leases with a term of one month or less. Additionally, can exclude expenses related to leases which are both short-term and low-value.
If the remaining lease term extends beyond 12 months (from the end of the previously determined lease term) or if the lessee becomes reasonably certain to exercise the purchase option, the short-term lease exemption can no longer be used. In such cases, the lease should be accounted for using ASC 842 or IFRS 16 lease accounting guidance as if the date of the change in circumstances were the commencement date.
Let’s say your lease is a 12-month lease ending December 31, 2022, with a renewal option for an additional 12 months. You exercise the option 2 weeks before lease expiration. You now have a lease that ends in 12 months and 2 weeks. Can it still be considered ‘short-term’? In this case the lease can still be classified as short-term. This is because the new lease term ends December 31, 2023, which is not more than 12 months past the previous term end date.
However, if the new lease term were to extend the lease beyond December 31, 2023 (more than 12 months past the original term end date of December 31, 2022), the lease would not qualify for the short-term lease exemption.
The short-term and low-value lease exemptions allow lease accounting to run through the income statement and not to impact the balance sheet in the form of an ROU asset and a lease liability. These exemptions are accounted for in the same manner as operating leases under the old lease standard.
When it comes to the proper lease accounting of short-term/low-value leases, download our free tool or invest in a software solution like NetLease for automated accounting. NetLease can store and track leases of all classifications, helping make your lease accounting and compliance easy and seamless. Use Netgain’s free short-term/low-value lease calculator to quickly and dynamically calculate the schedule for lease payment, lease expense, and deferred rent for leases using these exemptions.
About the Writer
Natalie Hunter, CPA, is a Senior Consultant at Netgain. After receiving a Master of Accountancy, she began her career at EY auditing both public and private companies in the life science, SaaS, and consumer products industries. Within her role at EY, she ensured public and private company compliance with ASC 606 and ASC 842. Having worked through the nuances of technical accounting compliance, she is excited to help make accountants lives better through streamlined processes and technology.