Partial Lease Terminations: Accounting and Best Practices under ASC 842

 In Bookkeeping

accounting for early termination of lease agreement

Under ASC 842 a lease that ends due to the lessee purchasing the underlying asset from the lessor does not constitute a lease termination. There are no laws that allow a tenant to break a lease early due to backing out of a lease after signing. Although circumstances may arise, a lease is a signed contract that binds the tenant and landlord in an agreement.

Scenario 4: Lessee agrees to lease a smaller space from the same lessor

Please make a copy of your early lease termination letter and note when your landlord received it. Please keep it on file as proof that you provided adequate notice you need to vacate the property accounting for early termination of lease agreement early. For month-to-month lease agreements, the process is simpler, but the landlord must provide a fair warning. This fair notice is 30 days in many states, but some have other requirements.

Practical tips for managing the impact of ASC 842 on lease termination decisions

  • Many lease agreements may include an option for either lessees or lessors to terminate the agreement prior to the end of the original lease term.
  • This means that the impact of a lease termination on a company’s financial statements is more significant under ASC 842 than under the previous lease accounting standard.
  • The tenant must vacate the property with its condition to be the same as on the move-in date.
  • Consider bringing on a property management company to handle all of the ins and outs of tenant turnover and leasing, communication, and more.
  • Many commercial leases have a fixed term, such as one year, three years, or more.

Jana Freer is a Real Estate Editor with Legal Templates, where she creates and edits legal form descriptions and articles to help landlords and tenants better understand real estate processes. She has held a California Real Estate License since 2006 and has worked as an agent with large brokerages in the United States, including Keller Williams Realty. If a state’s specific health and safety codes are not met, proper notice is given by the tenant. If the repairs are still not made within the allowable time period, a tenant would be considered “constructively evicted.” As a result, the obligations of the tenant under the lease are no longer required. If a lease agreement contains an early termination clause, before executing it and paying the penalty fee, read further to learn about other conditions that, if met, would not require a penalty fee to be paid. A sublease generally results in ordinary income treatment for a tenant.

Impact on lease vs. buy decisions:

accounting for early termination of lease agreement

Based on the revised information in the amended lease and using their new incremental borrowing rate of 3.75%, Shipping XYZ calculated their new lease liability to be $4,310,323.30 (decrease of $1,891,339.79). If the party requesting termination has no legal recourse, they will be required to obtain the other party’s consent. The best way of getting the other party to agree is to suggest a financial payout to terminate the lease. Rather than making a significant payment to a landlord to cancel a lease, tenants may be inclined to sell or sublease their lease to another lessee. This would first be predicated by a lease agreement permitting such sale/sublease or a landlord otherwise agreeing to it. In some states (such as Nevada and Washington), landlord-tenant laws allow survivors of domestic violence, sexual assault, stalking, or unlawful harassment to break a lease and move if necessary.

Please note that the language you see here may change depending on your answers to the document questionnaire. It is my/our request to terminate the Lease because (Termination Reason). Subletting relieves the landlord of finding a replacement tenant, making the request more agreeable. Once you have viewed this piece of content, to ensure you can access the content most relevant to you, please confirm your territory. These materials were downloaded from PwC’s Viewpoint ( under license.

accounting for early termination of lease agreement

One of its stores, located in a prime shopping center, is struggling to generate sales and is operating at a loss. As a result, ABC is considering terminating its lease and closing the store. And all companies will need to prepare for lease modifications that will take place after transition – a key ‘day two’ aspect of the new world of lease accounting. As of May 31, 2025 the remaining lease liability and right-of-use asset were $6,201,663.09 and $6,043,626.29 respectively. At the beginning of year 3, the lease liability was valued at $2,457,000 and the right of use asset $2,500,053. You may not be entitled to damages if you were late on rent or significantly damaged the property.

How to Terminate a Lease Early (4 steps)

Any difference between the balances of the lease asset and liability as of the date of termination will result in a gain or loss recognized on the income statement in the period of termination. Breaking a lease can be a complex and challenging process for both tenants and landlords. It is essential to understand the basics of breaking a lease to facilitate a smooth transition and avoid any legal consequences. A lease agreement is a binding contract between the tenant and the landlord, outlining the terms and conditions of the rental period. When a tenant decides to break the lease before its expiration, there are several factors you need to consider, such as the lease term, rental obligations, termination fees, and valid reasons for termination.

However, at the start of year three, Wigwam no longer requires the machine and immediately terminates the lease due to a new way of manufacturing. As stipulated in the lease contract, a lease termination incurs a $500,000 termination fee and, in doing so, will remove the obligation of future lease payments and have the ability to return the leased machinery. GASB 87 requires lessees to remeasure the lease liability and lease asset based on the adjusted payment terms. The lessee will calculate the adjustment to the lease liability and recognize an adjustment of the same amount to the lease asset, with any difference reflected in gain or loss for the current period. For example, if the lease liability decreases by $100 based on the new payment terms, the lessee must decrease the right-of-use asset value by $100. Lessors reporting under GASB 87 will remeasure the deferred inflow of resources, as well as the lease receivable, in the same manner.

Steps for Smoothly Handling Early Lease Terminations

A typical lease termination fee depends on the lease and the laws in your area, but it’s usually one or two months’ rent. Your landlord may also need to inspect the property before refunding your security deposit (if willing to do it at all). In your early lease termination letter, request a property inspection as soon as possible.

A lease termination letter lets a landlord or tenant end a month-to-month lease in compliance with their state’s laws. Either party can send this notice in the middle of a tenancy at will, and the tenant will have a certain period to vacate the property. Certain lease agreements provide specific terms that allow for tenants to terminate early in exchange for a penalty fee.

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