As part of a business combination, an acquirer may assume the existing leases of the acquiree, under which the acquiree is the lessee. Based on this transaction type, the acquirer must consider several factors.
Specifically, the acquired leases are measured, as of the acquisition date, as if they are newly signed by the acquirer. This requires the acquirer to assess the discount rate and remaining lease payments, considering the extension, purchase, and termination options.
This assessment may result in a different measurement of the lease liability and right-of-use (ROU) asset (discussed below) as compared to what is reflected on the acquiree's closing balance sheet. However, lease classification does not require reassessment unless leases are modified as a result of the acquisition. Assignment of a lease to the acquirer with no changes to the lease term or payments is generally not considered a modification.
The lease liability is measured as the present value of the remaining lease payments, based on the assessment of factors included above, and using the acquirer's discount rate, which may vary from the acquiree's original rate. As a result, the same remaining lease payments may result in a higher or lower balance than recorded on the acquiree's balance sheet.
Additionally, as part of the acquire's reassessment of the lease term, the acquirer's reasonable certainty around exercising renewal, termination, and/or purchase options in the context of its own operations may differ from that of the acquiree. For example, the acquiree may have concluded that it was reasonably certain that the lease would be renewed following the base term because the location was critical for a business unit. However, if the business unit is not significant to the acquirer (e.g., the intent of the acquisition was to achieve synergies with another part of the business), then the acquirer may reach a different conclusion. Only the renewal or termination options that the acquirer is reasonably certain to exercise are included in the lease term, regardless of the acquiree's previous conclusions.
The ROU asset, as of the acquisition date, is initially measured at an amount equal to the lease liability, adjusted for above or below market terms of the lease, consistent with acquisition accounting and fair value principles under ASC 805: Business Combinations. Thus, the ROU asset may be adjusted up or down to reflect the current state of the market. Previously, under ASC 840, this favorable or unfavorable adjustment was captured as an intangible asset. Under ASC 842, however, the ROU asset is adjusted directly.
In assessing the extent of procedures to perform in determining any fair value adjustment, companies should consider:
An acquirer may choose to apply the short-term lease practical expedient (i.e., leases with remaining terms of 12 months or less) for any leases acquired under which the acquiree is the lessee. This means that the acquirer would not recognize a lease liability or ROU asset or separately record the impact of above- or below-market terms.
As with all other areas, the acquiree must conform its accounting policies to those of the acquirer. If the acquirer is a public business entity and has already adopted ASC 842, but the acquiree was a private company still reporting under ASC 840, the acquiree must immediately adopt ASC 842, generally on a more compressed timeline.
Even if both parties have adopted ASC 842, adjustments may still be necessary if private company practical expedients were initially applied and are no longer permissible. For instance, an acquisition resulting in a private acquiree becoming part of a public business entity would require eliminating any expedients only available to private companies (e.g., use of the risk-free rate rather than the implicit or incremental borrowing rate).