What Is The Correct Accounting Treatment For A Situation Where A Company Receives A Prepaid Rent Payment From A Lessee In Advance Of The Lease Term, But The Lease Agreement Is Subsequently Terminated Due To A Non-renewal Clause, And How Would This Be Reflected In The Financial Statements Under Both ASC 840 (US GAAP) And IFRS 16?

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When a company, acting as a lessor, receives a prepaid rent payment from a lessee and the lease is subsequently terminated due to a non-renewal clause, the accounting treatment differs under ASC 840 and IFRS 16. Here's a structured summary of the correct accounting approach and its reflection in the financial statements:

Under ASC 840 (US GAAP):

  1. Initial Recognition:

    • The prepaid rent is recorded as a liability, typically under an account named Deferred Rent Revenue.

  2. Revenue Recognition:

    • Over the lease term, the Deferred Rent Revenue is gradually recognized as Rent Revenue on a straight-line basis or according to the terms of the lease agreement.

  3. Lease Termination:

    • Upon termination, the lessor must remove the lease-related asset and liability from the balance sheet.
    • Any unearned portion of the prepaid rent must be refunded. This involves:
      • Debiting Cash (to reflect the refund).
      • Crediting Deferred Rent Revenue (to clear the unearned portion of the prepayment).

  4. Financial Statement Impact:

    • Balance Sheet: The Deferred Rent Revenue liability is reduced, and cash is decreased by the amount refunded.
    • Income Statement: Rent Revenue is adjusted to reflect only the amount earned up to the termination date. Any refund is recorded as a reduction of revenue.

Under IFRS 16:

  1. Initial Recognition:

    • The lease is recognized as a finance lease. The lessor records a lease receivable (asset) and a corresponding lease liability.

  2. Lease Termination:

    • Upon termination, the lease receivable and lease liability are removed from the balance sheet.
    • Any prepaid rent received is treated as a refundable deposit. The lessor must return the unearned portion of the prepaid rent, which involves:
      • Debiting the Lease Liability (to remove the liability).
      • Crediting Cash (to reflect the refund).

  3. Financial Statement Impact:

    • Balance Sheet: The lease receivable and lease liability are derecognized. Cash is decreased by the amount refunded.
    • Income Statement: Lease income is adjusted to reflect only the amount earned up to the termination date. Any refund is recorded as a reduction of income.

Key Differences Between ASC 840 and IFRS 16:

  • ASC 840: Focuses on the deferral and recognition of rent revenue over the lease term. The termination leads to the refund of unearned rent and adjustment of revenue.
  • IFRS 16: Involves the derecognition of lease receivable and liability upon termination, with the refund of prepaid rent treated as a reduction of the lease liability.

In both cases, the financial statements are adjusted to reflect the termination of the lease agreement and the refund of any unearned prepaid rent, ensuring accurate representation of the company's financial position and performance.