Partial Lease Terminations: Accounting and Best Practices under ASC 842

Last Updated on July 21, 2023 by Morgan Beard

Introduction

As a lessee, it’s important to understand how to properly account for partial lease terminations to ensure accurate financial reporting and maintain compliance with ASC 842. In this blog post, we will break down the complexities of termination accounting under ASC 842 and provide practical considerations and best practices for accounting for partial lease terminations.

Recap of Lease Terminations under ASC 842

Under ASC 842 lease terminations occur when a lessee or lessor ends a lease before the original lease term expires. Partial lease terminations, in particular, involve terminating only a portion of the leased asset, while the remaining portion continues to be leased. This may happen, for example, when a lessee downsizes their space in a leased building or returns a portion of leased equipment. Given the abundance of partial terminations in today’s economy it’s important to understand the accounting implications of such transactions.

Accounting for Partial Lease Terminations 

Accounting for partial lease terminations involves adjusting the lease liability and the right-of-use (ROU) asset. The lease liability should be allocated between the terminated and non-terminated portions of the lease based on the relative fair value or by using the allocation based on the remaining lease payments. The ROU asset should also be adjusted accordingly to reflect the changes in the lease liability. Any gain or loss resulting from the partial lease termination is recognized in the Income Statement. An example of partial termination accounting, including the related journal entries will be discussed later on in this blog post.

Example of Partial Termination Accounting

To illustrate the impact of partial terminations on lease accounting under ASC 842 we have prepared the example below. 

Let’s assume XYZ Shipping enters into an operating lease agreement commencing on June 1, 2023. The agreement states that XYZ Shipping will lease two floors of a building for their new headquarters  office space at $250,000 per month increasing by 2.5% over a period of 4 years. XYZ Shipping has determined it will use its incremental borrowing rate of 3%.

Based on the information above, XYZ Shipping has calculated its initial lease liability and right-of-use asset to be $11,743,775.88 on June 1, 2023.

During 2025 XYZ Shipping encountered rough financial times and had to downsize their headcount drastically. As such, on June 1, 2025 XYZ Shipping amended their headquarters lease to now only include one floor. Under the new amended terms XYZ Shipping will not only pay $183,859.38 per month. The term of the lease remains unchanged.

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.

To account for the partial termination of their headquarters lease XYZ Shipping first calculated the net change in their lease liability. 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).

To determine the change in the right-of-use asset XYZ Shipping can utilize one of two approaches which will be outlined below.

The first approach that can be used is to calculate the proportionate change in the lease liability. This is done by dividing the different in the lease liability by the pre-amendment liability to arrive at a percentage. In this example the proportionate change would be ($6,201,663.09 – $4,310,323.30  / $6,201,663.09) = 30.5%. This calculated proportion is then applied to the pre-amendment right-of-use asset to arrive at the calculated change of $1,843,306.02 ($6,043,626.29 * 30.5% = $1,843,306.02).

This calculated change is then subtracted from the pre-amendment right-of-use asset to arrive at a post-amendment right-of-use asset of $4,200,320.27 ($6,201,663.09 – $1,843,306.02 = $4,200,320.27).

The final step in the first approach is to calculate the gain on termination. This equates the difference between the change in the lease liability and the change in the right-of-use asset. In this example the gain equals $110,003.30 ($4,310,323.30 – $4,200,320.27 = $110,003.30).

The coinciding journal entries would be:

Dr. Lease Liability $4,310,323.30

   Cr. Right-of-use asset $4,200,320.27

   Cr. Gain on Termination $110,003.30

The second approach for accounting for a partial termination would be to calculate the proportionate change in the right-of-use asset.

In the original lease arrangement XYZ Shipping leased two identical floors with equivalent square footage. In the amended lease XYZ Shipping downsized this space to only one floor. Therefore to calculate the proportionate change in the right-of-use asset XYZ Shipping would perform the following calculation- 2 floors – 1 floor / 2 floors = 50%.

Similar to the first approach XYZ Shipping would then adjust the pre-amendment right-of-use asset by 50%- $6,043,626.29 * 50% = $3,021,813.14

Under this approach XYZ Shipping would then also reduce the pre-amendment lease liability by the same proportion- $6,201,663.09 * 50% = $3,100,831.54

Similar to the first approach the delta between the change in the liability and the change in the right-of-use asset would equate your gain on termination- $3,100,831.54 – $3,021,813.14 = $79,018.41

The coinciding journal entries would be:

Dr. Lease Liability $3,100,831.54

   Cr. Right-of-use asset $3,021,813.14

   Cr. Gain on Termination $79,018.41

Unlike the proportionate change in the lease liability approach- this second approach requires a second set of journal entries to appropriately record the partial termination.

This second set of journal entries is driven by the difference in the amended lease liability (calculated at the outset of this example) of $4,310,323.30 and the proportionately changed lease liability of $3,100,813.54. This value is $1,209,509.76

Therefore the second journal entry to close out the second approach of accounting for a partial termination would be:

Dr. Right-of-use asset $1,209,509.76

   Cr. Lease liability $1,209,509.76

As you can see above both approaches result in similar end values for the lease liability and right-of-use asset but the method to arrive at the values is slightly different.

It should be noted that under ASC 842 both the first and second approach are permissible and under IFRS 16 only the second approach can be used.

Further, an organization shall apply the same approach for all partial terminations across all leases as a policy election.

Impact on Financial Statements and Disclosures 

Partial lease terminations can have a significant impact on the financial statements. The gain or loss recognized from the partial lease termination affects the lessee’s net income, and the adjustments to the lease liability and ROU asset impact the Balance Sheet. It’s also crucial to properly disclose the details of the partial lease termination in the financial statements, including the impact on net income, any gains or losses recognized, and other relevant qualitative information. Adhering to the disclosure requirements of ASC 842 ensures both transparency and compliance.

Practical Considerations and Best Practices 

Accounting for partial lease terminations requires careful consideration. Here are some practical tips and best practices to keep in mind:

1. Review Lease Agreement: Thoroughly review the lease agreement and documentation to understand the terms and conditions associated with the partial lease termination. This includes any changes in lease terms, payments, or other considerations resulting from the termination.
2. Seek Professional Guidance: ASC 842 is a complex accounting standard, and it’s advisable to seek professional guidance from qualified accountants or financial advisors to ensure compliance and accuracy in financial reporting.
3. Consider Tax Implications: Partial lease terminations may have tax implications, and it’s important to consider the tax consequences, such as gains or losses recognized for tax purposes. Consult with tax professionals to understand the tax implications and ensure compliance with tax regulations.
4. Update Disclosures: Update the financial statement disclosures to provide comprehensive information about the partial lease termination, including the impact on net income, gains or losses recognized, and other relevant details. Proper disclosure ensures transparency and compliance with ASC 842 requirements.
5. Maintain Proper Documentation: Keep proper documentation of the partial lease termination, including the lease agreement, adjustments made to the lease accounting system, professional guidance obtained, and other relevant information. Proper documentation supports accuracy and compliance in lease accounting and can assist you through the audit process.
6. Regularly Review Lease Portfolio: Regularly review the lease portfolio to identify potential lease terminations, including partial lease terminations, in a timely manner. This allows for proactive planning and accounting for terminations in accordance with ASC 842.

Conclusion

Accounting for partial lease terminations under ASC 842 can be complex, but with proper understanding and adherence to best practices, lessees can ensure accurate financial reporting and compliance with the accounting standard. Thoroughly reviewing the lease agreement, seeking professional guidance, considering tax implications, updating financial statement disclosures, maintaining proper documentation, and regularly reviewing the lease portfolio are all important practical considerations to keep in mind.

By following these best practices, lessees can confidently navigate the complexities of partial lease terminations and ensure that their financial statements accurately reflect the impact of these terminations on their financial position and results of operations.

At Occupier, we understand the challenges of accounting for partial lease terminations under ASC 842, and our team is here to provide support. Contact us today to learn more about how we can assist you in navigating lease terminations and compliance with ASC 842.