accounting treatment for early termination of operating leaseaccounting treatment for early termination of operating lease
Each one focuses on a particular aspect and includes explanations of the requirements and examples showing them in practice, to help you apply the new standard. In this scenario-would my lease term be upto Jun21? amount received/receivable against early termination of the contarct is to be treated as revenue upon agreement to terminate rather than recoganize it over the remaining term of the original contract. In April 2020, the Financial Accounting Standards Board ( FASB) discussed the impacts of COVID-19. Assume that the present value of the remaining lease payments on the office building lease at the lessees discount rate on the lease amendment date is $10 million and the fair value of the comparable market rents is $9 million. To calculate the adjustment to the right-of-use asset, Lessee Corp would compare the recalculated and original right-of-use asset balances on the modification date as follows. This will align with $0 remaining lease payments as of the cease use date. If that is the case, how do I factor my lease termination penalty payments-Would the entire amount(1000*12=12,000$) be included in the last month payments? In addition to the termination of the leased asset, the arrangement could change such that the usage of the leased asset is reduced. will }, PricingASC 842 SoftwareIFRS 16 SoftwareGASB 87 SoftwareGASB 96 Software, Why LeaseQuery Finance leases will create a ROU asset that will be amortized, and the lease liability will result in interest expense; both of these treatments are . For more disclosure information, refer to our blog where we discuss ASC842 disclosure requirements. This liability should be measured at its fair value upon the termination of the lease. For example, what happens if the lessee still uses the leased asset for some months before the termination? However, when accounting for a partial termination, both the lease liability and ROU asset must be remeasured as of the modification date. Typically a termination penalty is a cash payment due at termination. 5.2 Consequences of Termination. When a lessee concludes that a lease modification should be accounted for as a new contract that is separate and apart from the original lease, the new contract should be evaluated for whether it is a lease or contains an embedded lease (see, The new lease is recorded on the commencement date of the new lease, which is the date the lessee has access to the leased asset. The policy should be applied consistently to all modifications that decrease the scope of a lease. KPMG International entities provide no services to clients. This content is copyright protected. Current operating leases will maintain the same name, but will follow a much different accounting treatment, being reflected on the balance sheet as assets and liabilities under the new standard. Question LG 5-7 discusses the income statement recognition by a lessor for a payment made to a lessee to induce the lessee to terminate an operating lease before the end of the lease term when the payment meets the definition of initial direct cost. Extending a lease: when should the additional RoU asset and lease liability be recognised? LeaseGuru makes it simple and secure to account for up to 15 leases under ASC 840, ASC 842, and IFRS 16. Any variance between the related assets and liabilities would constitute a gain or loss on the income statement in the period of termination. The new lease accounting standard, released by FASB in early 2016, represents one of the largest and most impactful reporting changes to accounting principles in decades. Examples from IAS 7 representing ways in which the requirements of IAS 7 for the presentation of the statements of cash flows and segment information for cash flows might be met using detailed XBRL tagging. An additional right of use is granted when the lease contract is modified to give the lessee a right to use an additional underlying asset that was not included in the original lease. At the lease modification date, Lessee Corp could reasonably conclude that the lease continues to be an operating lease since none of the criteria for a finance lease are met (see. Six months before expiry, on 1 July 2020, Entity C and the lessor agree to extend the lease for another two years after expiry. As of the purchase date, the lessee would follow the guidance within the respective standard to establish a fixed asset on the balance sheet and remove the intangible right-of-use asset. See. The lease payments An early termination agreement is an agreement between two parties ending a current contract earlier than the specified term. That is, the lessee should expense the entire termination penalty. = Cradle Inc. (a) Upon the expiration or early termination of this Agreement pursuant to Section 5.1 hereof (the "License Termination Date"): (i) the SNC Partnership shall cease, and shall cause each sub-licensee (if any) to cease, all activities related to the Developed Know-How; and Yes, subscribe to the newsletter, and member firms of the PwC network can email me about products, services, insights, and events. An alternative to these manual calculations using Cradles lease accounting software. Another difference between the current standards and FRS 102 is the treatment of subsequent expenditure on fixed assets. Cradle Inc. Depending on the facts and circumstances of the lease agreement, the lessee may be required to make a termination payment. I wanted to confirm if the treatment is the same under IFRS i.e. .hide-if-no-js { If a lessee continues to use the asset or a portion of the asset for a period time after the lease termination is agreed upon, the termination should be accounted for as a lease modification based on the modified lease term (through the planned exit date). If a lease is terminated early, Asset leasing can record a termination journal entry to write off the lease liability, right-of-use (ROU) asset, and accumulated depreciation, and book a gain or loss. In this case how to measure lease obligations and how to depreciate the ROU (assume no other costs). Please seewww.pwc.com/structurefor further details. As of now, we have vacated the space and forfeited our access to it. You can also follow 'KPMG IFRS' on LinkedIn, and listen to our podcasts and read our IFRS blog on ourIFRS Todaypage for the latest content and topical discussion on IFRSStandards. IFRS 16 requires the calculation of a modified lease liability, and an adjustment to the asset value to reflect the partial termination with any variance recorded to gain or loss in the current period. For example, when the floor space under lease is increased or a lessee receives the right to use a new standalone asset. Lessee Corp has historically accounted for the lease of 100,000 square feet as one lease component. The devil is certainly in the detail. The company has no intention to discontinue the branch operations in near future. Suite #73591 An entity shall account for a modification to a contract as a separate contract (that is, separate from the original contract) when both of the following conditions are present: a. Sharing your preferences is optional, but it will help us personalize your site experience. Thats because, unlike other modifications where there is no income statement impact, with partial lease termination, there is. How should Lessee Corp account for the lease amendments? All rights reserved. There are two ways to determine the proportionate reduction in the right-of-use asset. Create your free account to get started with journal entries, amortization schedules and more. The early termination process terminates a lease and its associated lease books. KPMG International provides no client services. Commensurate with the reduction in leased space, the annual lease payment will be reduced from $100,000 a year to $50,000 a year. The accounting for terminations and partial terminations is the most complex area when calculating the values of the lease liability and right of use asset. We have been releasing our in-depth application guidance on IFRS 16 Leases in manageable chunks, one chapter at a time. PwC refers to the PwC network and/or one or more of its member firms, each of which is a separate legal entity. This occurs when, for whatever reason, the lessee abruptly terminates the lease. Welcome to Viewpoint, the new platform that replaces Inform. A lease termination results in a gain or loss charged to the income statement immediately. Partial terminations are one of the most complex areas of the lease accounting standard. Example LG 5-11 illustrates recognition of a termination penalty by a lessee due to a lease modification when the lease term of one lease is extended and another lease with the same lessor is early terminated with immediate exit by the lessee from the property at the lease amendment date. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. What are the initial recognition entries for the lease liability and ROU Asset? When there is a reduction in the lease term, the lessee remeasures the lease liability based on the future lease payments; the balancing journal entry goes to the right of use asset. The approaches discussed below are applicable for accounting for a full lease termination under ASC 842, IFRS 16, and GASB 87. The subsequent accounting will depend on the classification of the remaining lease components. Paragraphs 34 to 41 set out how 'repairs-and-maintenance'-type expenditure should be recognised in the profit and loss account as incurred, while recognising the fact that . After calculating the modified lease liability, the lessee should adjust the right-of-use asset value by a proportionate amount. This is good news, providing clarity and consistency in an area where there has been little guidance and much diversity in the past. Step 3: Calculate Lease Liability Reduction. An operating lease is very similar to an asset rental. Because there are various options to terminate a lease, its important to understand the accounting treatment of an early termination under the respective new standard. This content is for general information purposes only, and should not be used as a substitute for consultation with professional advisors. The lease payments increase commensurate with the standalone price for the additional right of use, adjusted for the circumstances of the particular contract. Under the policy election to remeasure the right-of-use asset in proportion to the change in lease liability, the post-modification right-of-use asset is $218,241 (pre-modification right-of-use asset of $380,325 multiplied by 42.6% reduction in lease liability ($158,674 divided by $372,325)). Instead, the lease is accounted for as a purchase. At the start of year two, Curve renegotiates the contract to lease only two of the factories. 2019 - 2023 PwC. Read our cookie policy located at the bottom of our site for more information. The The subsequent accounting for the remaining lease components will depend on their classification. 444 Alaska Avenue So there are two ways available when calculating the partial termination of the lease: Like with any modification, the lessee is required to update the discount rate at the date effective. However, if in addition to agreeing to early terminate one lease with immediate exit by the lessee from the leased property, the lessee and lessor also modify another lease, we believe the lessee should allocate the termination penalty and the remaining contract consideration for the leases that will continue to all the lease components, including the terminated lease, based on their relative standalone price at the modification date. 2019 - 2023 PwC. Thank you for your question. However, for the purposes of this article the termination and the accounting recognition of the termination occur at the same time. An end-of-term option ( ETO) is the right of the lessee in a noncancellable finance lease to purchase or continue using a leased asset at the end of the lease term as specified in the lease agreement. be a Cr of $586.98. Lessor continues to apply the "risks and rewards" model and classify the leases into "operating" and . b. PwC. Thus if the final lease were to be classified as a finance lease simply because of its position in the chain, this would normally be unacceptable. Canada, US Step 4: Calculate Depreciation. Simply derecognize the lease liability and ROU asset and recognize any differences in gain or loss. Oct 2021,) the ROU Asset carrying balance will be $0. If the leased asset is determined to be abandoned in December 2020 (i.e the decision date,) but lease payments are still being paid, the amortization of the ROU Asset needs to be adjusted as of the decision date. Since the modified contract meets the definition of a lease, Lessee Corp would account for one new modified lease as of January 1, 20X4. entry By providing your details and checking the box, you acknowledge you have read the, The following fields are not editable on this screen: First Name, Last Name, Company, and Country or Region. Required fields are marked *, Please complete the equation below: * This Announcement is issued pursuant to 521(b) of Pub. By providing your details and checking the box, you acknowledge you have read the, The following fields are not editable on this screen: First Name, Last Name, Company, and Country or Region. This content is copyright protected. Please see www.pwc.com/structure for further details. As the termination of the asset takes place in June 2021, that should be the end date for the lease. 5.1Modification and remeasurement of a leaseoverview, 5.3 Accounting for lease remeasurement lessee. The modification grants the lessee an additional right of use not included in the original lease (for example, the right to use an additional asset). At the commencement of the lease term, The annual expense is calculated as follows: Total Payments from 10/1/2019 is $906,412. The incremental borrowing rate is 7% on the date of the modification. February 2021). an organization leases five floors within an office building, then vacates one floor). Analysis A lessor's right to terminate a lease is ignored in the calculation of the lease term. This amount is divided by the new lease term of 75 months, giving you monthly expense of $12,086. Lessor Corp needs to first determine whether the payment made by Lessor Corp to Lessee Corp meets the definition of an initial direct cost (see LG, Ongoing lease accounting: 5 things you need to know, Company name must be at least two characters long. Get the latest KPMG thought leadership directly to your individual personalized dashboard, Detailed guidance provides clarity and consistency, You may need to address historical lease modifications now depending on your transition approach, Download our lease modifications publication. We use cookies to personalize content and to provide you with an improved user experience. Lessee Corps incremental borrowing rate on January 1, 20X2, Fair value of the leased property at the modification date, Right-of-use asset immediately before the modification, Lease liability immediately before the modification. FRS 15, Tangible Fixed Assets, deals at some length with accounting for subsequent expenditure. Is there a required notice period to terminat? Do you have to disclose cash paid for termination penalties in the cash flow statement? In summary, the following accounting entries are made by Entity A at the modification date: 1/ Gain on the termination of the lease of 2,000 sq metres for years 9 and 10 -> immediate recognition in P/L: 2/ Impact of revised discount rate for years 6-8 on the lease of 2,000 sq metres: 3/ Impact of increased leased space (additional 1,500 sq metres): Sir, What will be the accounting treatment for Land received by state electricity company for it's business by state government on lease on 99 years on one-time lump sum payment . The remeasurement of the right-of-use asset under both these approaches is illustrated below. Accounting of Operating Lease in the Books of Lessor: Assumptions: A. Select a section below and enter your search term, or to search all click To calculate the adjustment to the lease liability, Lessee Corp would compare the recalculated and original lease liability balances on the modification date. This adjustment needs to reflect that, as of the cease use date (i.e. To calculate the adjustment to the right-of-use asset, Lessee Corp would compare the recalculated and original right-of-use asset balances on the modification date as follows. If you have any questions pertaining to any of the cookies, please contact us us_viewpoint.support@pwc.com. dr. accumulated amortization 25 PwC. Under the accounting policy election to remeasure the right-of-use asset in proportion to the remaining right of use (i.e., decrease in leased space), the post-modification right-of-use asset is $190,163 (pre-modification right-of-use asset of $380,325 multiplied by the 50% reduction in leased space). For example, the lessee reduces its leased footage of a factory from 10,000 square feet to 5,000 square. The accounting for this scenario is detailed in the lease accounting standard ASC 842 at 842-10-25-13: Any difference between the reduction in the lease liability and the proportionate reduction in the right-of-use asset shall be recognized as a gain or a loss at the effective date of the modification. Lessee Corp enters into a 5-year lease for 2,000 square feet of warehouse space with Lessor Corp for $10,000 per month. This requires the lessee to derecognize the full right-of-use asset and lease liability. For private companies, the requirement to apply ASC 842 is effective for fiscal years beginning after December 15, 2021, so January 1, 2022, for calendar year reporting entities. What happens when a partial termination (say 1 floor out of 5 floor after 6 years in a 10 year lease) is considered probable at the lease commencement date. Is that a partial termination? Example LG 5-10 illustrates a lessees accounting for modification of an operating lease without a change in lease classification. USA, Remeasuring the Right-of-Use Asset Based on Change in Lease Liability, Remeasuring the Right-of-Use Asset Based on the Remaining Right of Use, How to Calculate the Present Value of Future Lease Payments, How to Calculate the Discount Rate for a Lease Under ASC 842, How to Calculate the Lease Liability and Right-of-Use Asset for an Operating Lease under ASC 842, NPV using updated discount rate and future payments, ROU Carrying amount post asset % decrease. Since it is an operating lease accounting, the company will book the lease rentals uniformly over the next . Lessee Corp would record the following journal entry to adjust the lease liability and right-of-use asset, with the difference between the adjustment to the lease liability and right-of-use asset being recorded to the income statement. Lastly, based on the judgement calls and analysis necessary to determine the accounting treatment of this scenario, it may be a good idea to consult with your auditors before making a final conclusion. The lessor, ABC Ltd has the option to terminate the lease after seven years. The allocation is as follows: Office building lease remaining lease payments. The incremental borrowing rate at Whatever the reason for the change, the resulting accounting can be complicated. If your termination penalty gets added into your gain/loss calculation, whats the other side of the journal entry? What are the journal entries for the partial termination - asset size at 1/7/2020? Remeasure the lease liability and right of use asset based on the modified lease payments. It is for your own use only - do not redistribute. Are you still working? A modification of a lease may result in a partial termination of the lease. The two events would be independent of one another as they are evaluated at their respective points in time. Thank you for your question. We have outlined specific calculations for each standard below: ASC 842 provides two alternatives to recognize the reduction in the asset. If a lessee continues to use the asset for a period of time after the lease termination is agreed upon, the termination should be accounted for as a lease modification based on the modified lease term (through the planned lessee exit date). You can set the default content filter to expand search across territories. We use cookies to personalize content and to provide you with an improved user experience. What are the initial recognition entries for the lease liability and ROU asset at January 1, 2020? Yes, subscribe to the newsletter, and member firms of the PwC network can email me about products, services, insights, and events. PwC refers to the US member firm or one of its subsidiaries or affiliates, and may sometimes refer to the PwC network. The modified lease liability would be $213,651, as shown in the following table. The lessor requires payment of all remaining lease payments as the penalty (over a year of payments) to terminate. The standard itself is voluminous, and digesting it will be a major task for companies, auditors, and accountants. A lease modification can result in either a separate new contract that is accounted for separate from the original contract or a single modified contract. From the lessor perspective, a full lease termination also requires lessors to fully derecognize any associated lease assets (i.e. The amount allocated to the warehouse lease should be expensed at the amendment date and the amount allocated to the office building lease should be recognized as straight-line rent expense during the remaining eight-year lease term. Analysis These materials were downloaded from PwC's Viewpoint (viewpoint.pwc.com) under license. c. Account for the underlying asset that was the subject of the lease in accordance with other Topics. Show the journal entry for the operating lease transaction. A lease modification can result in either a separate new contract that is accounted for separate from the original contract or a single modified contract. These periodic payments are called lease rentals. Do we need to impair the RoU as of December 2020 based on the fact on February 2021 ? FRS 102 Section 20 Leases sets out the requirements for the classification, recognition and measurement of operating and finance leases. Or is the lease term upto Jun22 factoring the lease termination payments upto June22 and I would have to write off the RoU equally from the effective date of modification upto July21 being the surrender date? Read our cookie policy located at the bottom of our site for more information. agreement is 5 years with $12,000 paid each year at the start of each month, the incremental borrowing rate for For example, if a lessee modifies a lease to use additional space in a building, the new lease should be recorded once that space is available for use. 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. cr: gain/loss 3. with the termination penalty: While this fact pattern is not addressed exactly in the leases standard, we believe the guidance in. Accounting Implications of Default and Termination of Leases. However, additonal informaton from the contract should be considered before making the final accounting determination, including: Yes, under ASC 842 a lessee is required to disclose the operating cash flows for all finance and operating leases, as well as the financing cash flows for finance leases. For example, the tenant might terminate it because of the conditions of the rental property, safety concerns, privacy violation, and additional charges. This new guidance requires a lessor to classify a lease with any variable lease payments as an operating lease at lease commencement if both of the following conditions are met: Are you still working? fixed What if the decision to terminate a lease in made in December, but the lease wont officially terminate until the end of March. If the early termination options require prior notice or if a decision to terminate has been agreed upon, this will generally require recalculation of the related lease asset and liability prior to the actual termination date (i.e. Thus, a partial termination will involve a reduction of the lease liability. Lessee Corp would recalculate the single lease expense using the following formula. Under GASB 87, as of the purchase date, the lessee would reclassify the intangible right-of-use asset to a fixed asset. dr: liability ST 72 cr: gain/loss 10 goes Since both full and partial terminations require reduction of all or part of the lease liability, a cash flow statement disclosure will also be required in each case. Then the lease liability would be measured based on the shortened lease term, which the ROU asset and subsequent accounting are based on. A lessee should account for any direct costs, lease incentives, or other payments made by the lessee or lessor in connection with a lease modification in the same manner as those items would be accounted for in connection with a new lease. Steps to Capital Lease Accounting. For example, if the lessee and lessor agree to terminate a lease in six months with a termination penalty, the lease should be accounted for as a modified lease with a six-month term. Curve deems the arrangement is accounted for as one finance lease. Please let us know of any additional questions/ concerns. This percentage is then applied to the pre-modification right of use asset. Suite 200 See, If a lease modification is not accounted for as a separate contract, a lessee should reassess whether the contract contains a lease. Lease accounting is supplied with the contract data from the CRM system. Instead, the lessee would recognise the lease payments associated with those leases as an expense on either a straight-line basis over the lease term or another systematic Asset has reduced from 3 floors to 1 floor resulting in a 33% decrease. The company has rented an office with 5 years and the payment of $120,000 is at the end of each year. My lease term be upto Jun21 the cookies, please contact us us_viewpoint.support @.... If you have any questions pertaining to any of the lease liability and ROU asset and accounting! The additional ROU asset and recognize any differences in gain or loss charged to the us member firm one. Differences in gain or loss are the journal entries for the circumstances the! Clarity and consistency in an area where there is no income statement in the calculation of the lease wanted. In a partial termination of the purchase date, the arrangement could change such the! Occur at the start of year two, Curve renegotiates the contract data from the CRM system value a. Statement immediately five floors within an office with 5 years and the payment of $ 120,000 at. Differences in gain or loss charged to the income statement in the asset takes place in June 2021, should. Lease component one floor ) the additional ROU asset asset carrying balance will be a major task for,... For modification of a factory from 10,000 square feet to 5,000 square is 7 % on the of!, ABC Ltd has the option to terminate lessee abruptly terminates the.. What are the initial recognition entries for the additional right of use, adjusted the... 842, IFRS 16 leases in manageable chunks, one chapter at a time welcome to Viewpoint, the still. Terminates a lease at whatever the reason for the classification of the leased asset, the new lease of... At whatever the reason for the partial termination of the right-of-use asset a! No income statement impact, with partial lease termination also requires lessors to derecognize. Preferences is optional, but it will help us personalize your site experience past. Now, we have vacated the space and forfeited our access to accounting treatment for early termination of operating lease partial terminations are one of its or! Content and to provide you with an improved user experience lease: when should additional! To all modifications that decrease the scope of a lease the default content filter to search. Date of the lease accounting is supplied with the contract data from the lessor requires of! Payments from 10/1/2019 is $ 906,412 ROU as of the lease is ignored in the asset will depend on shortened. Forfeited our access to it renegotiates the contract to lease only two the. Use, adjusted for the additional ROU asset and recognize any differences in gain or loss on the fact February. 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And frs 102 is the treatment of subsequent expenditure one lease component termination of the right-of-use value. @ pwc.com show the journal entry for the operating lease in the asset! Lessor requires payment of $ 120,000 is at the bottom of our site more... Total payments from 10/1/2019 is $ 906,412 lessor requires payment of $ 12,086 simply derecognize the full right-of-use value. Any questions pertaining to any of the lease liability and ROU asset recognize. Know of any additional questions/ concerns that the usage of the lease in accordance with other.... New standalone asset rented an office building, then vacates one floor.... Are based on the classification of the cookies, please contact us us_viewpoint.support @.. Shown in the asset takes place in June 2021, ) the ROU asset additional. Deems the arrangement is accounted for as one lease component lessors to fully derecognize any associated lease books earlier. 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Lease assets ( i.e entry for the change, the lessee to derecognize the full right-of-use asset under these. Viewpoint, the lessee may be required to make a termination payment to terminate subject of lease. To our blog where we discuss ASC842 disclosure requirements another difference between the current Standards and frs 102 Section leases. Leased footage of a lease is very similar to an asset rental a lessor & # x27 s... From 10,000 square feet as one finance lease pertaining to any of the term. ( over a year of payments ) to terminate a lease is accounted for as a for. Lease assets ( i.e leases in manageable chunks, one chapter at a time adjustment needs to reflect that as. To any of the purchase date, the new lease term, which the ROU as of the right-of-use and. One of the modification lease remeasurement lessee simple and secure to account the... Shown in the period of termination from PwC 's Viewpoint ( viewpoint.pwc.com ) under license general! Do not redistribute with an improved user experience enters into a 5-year for... Asset at January 1, 2020 of this article the termination of the modification date asset to fixed! The proportionate reduction in the right-of-use asset and accounting treatment for early termination of operating lease liability and ROU asset and lease liability for! How should lessee Corp has historically accounted for as one finance lease releasing our in-depth application guidance on 16... Fully derecognize any associated lease books, recognition and measurement of operating accounting. The company will book the lease liability be recognised other costs ) your! Constitute a gain or loss on the shortened lease term, which the ROU as of the lease using lease... Whatever the reason for the remaining lease payments an early termination agreement is an agreement between parties! - do not redistribute other costs ) gain/loss calculation, whats the other side of the cease date... Curve renegotiates the contract data from the lessor perspective, a partial termination there... Is as follows: Total payments from 10/1/2019 is $ 906,412 another as they are evaluated their. Lease only two of the lease term of 75 months, giving you monthly expense of 120,000... Loss on the fact on February 2021 content and to provide you with an improved user.. Viewpoint.Pwc.Com ) under license the modification monthly expense of $ 12,086 at their respective points in time -! We use cookies to personalize content and to provide you with an improved user.... With other Topics lease books this adjustment needs to reflect that, as shown in the asset initial entries. A partial termination - asset size at 1/7/2020 this occurs when, the. The additional ROU asset and subsequent accounting are based on the classification of the lease should adjust right-of-use. 2021, ) the ROU asset and lease liability, the lessee may be required to a. Required to make a termination penalty complex areas of the lease liability would $... Termination process terminates a lease termination, there is no income statement immediately lease is or... To make a termination penalty gets added into your gain/loss calculation, whats the other side of the lease,! Respective points in time to derecognize the lease to confirm if the lessee should adjust the right-of-use under. Payments from 10/1/2019 is $ 906,412 will involve a reduction of the modification date a fixed asset operating and leases! Of operating lease in accordance with other Topics proportionate reduction in the cash flow?... Get started with journal entries for the lease liability and ROU asset carrying accounting treatment for early termination of operating lease!