NeedsLease entered into a ten-year operating lease for office space in accordance with ASC 840, Leases. It has neither renewal option nor the ability to negotiate for renewal per lease agreement. Within the leased premise, NeedsLease has placed into service various leasehold improvements that have economic useful lives of 12 years. In the lease agreement, there are certain provisions that may require the lessee to perform certain activities and to incur certain costs at the end of the lease term. Such provisions include:
• Lessor may require the lessee to perform general repairs and maintenance on the leased premises.
• Lessor may require the lessee to remove all leasehold improvements, restoring to original condition.…show more content…
The lease provision that requires the lessee to remove the capitalized leasehold improvements at the end of the lease term does create legal obligation and that should be within the scope of asset retirement obligation.
ASC 410-20-15-3(e) also states that the lessee’s obligation to perform a retirement activity shall be recorded as ARO unless the payment meets the definition of minimum lease payments or contingent rentals under the lease accounting literature (ASC 840, Leases). Per ASC 840-10-25-5, the minimum leases payment is any costs obligated to make in connection with the leased property. However, the lessee’s obligation to restore the leased asset to the original condition is related to the leasehold improvement, not directly related to the leased asset. Accordingly, the cost of removing the leasehold improvements is not part of the minimum lease payment. In addition, due to the ‘no renewal option’ and ‘no ability to negotiate for the renewal’ under the lease agreement, it is certain that NeedsLease will incur costs to restore the leased property to its original condition in 10 years, which excludes the ‘contingency’. Therefore, the cost of reinstating to the property’s original condition should be accounted as ARO in accordance with ASC 410-20. Per ASC 410-20-25-4, ARO should be recognized at its fair value of reasonably estimated future cash flows and to offset the liability, the lessee capitalize the