Beware of COVID 19 Rent concessions IFRS accounting

Beware of COVID 19 Rent concessions IFRS accounting

IFRS 16 amendments Corona Rent concessions provide relief to lessees in accounting for rent concessions.

IFRS 16 Rent concession amendments in a nutshell

The lessee perspective

The amendments to IFRS 16 add an optional practical expedient that allows lessees to bypass assessing whether a rent concession that meets the following criteria is a lease modification:

  • it is a direct consequence of COVID-19; Beware of COVID 19 Rent concessions IFRS accounting
  • the revised lease consideration is substantially the same as, or less than, the original lease consideration;
  • any reduction in the lease payments applies to payments originally due on or before June 30, 2021; and
  • there is no substantive change to the other terms and conditions of the lease.

Lessees who elect this practical expedient account for qualifying rent concessions in the same way as changes under IFRS 16 that are not lease modifications. The accounting will depend on the nature of the concession, but one outcome might be to recognize negative variable lease payments in the period in which the lessor agrees to an unconditional forgiveness of lease payments.

Lessees are required to apply the practical expedient consistently to similar leases and similar concessions. They must also disclose if they elected the practical expedient and for which concessions, as well as the amount recognized in profit and loss in the reporting period to reflect changes in lease payments that arise from rent concessions to which they have applied the practical expedient.

The amendments are effective for reporting periods beginning after June 1, 2020, with early application permitted.

The lessor perspective

The practical expedient does not apply to lessors. Instead, lessors are required to assess whether rent concessions are lease modifications and, if so, to apply the specific guidance on accounting for lease modifications. Beware of COVID 19 Rent concessions IFRS accounting

Not all rent concessions are in scope of the practical expedient

The practical expedient applies only to eligible rent concessions and eligibility is strictly time-limited. Companies will have to apply judgment to determine which rent concessions are in scope of the practical expedient.

A direct consequence of COVID-19

The evaluation of whether a rent concession occurs as a direct consequence of COVID-19 is based on the specific facts and circumstances, which may include:

  • the reasons for the initial negotiation between the lessee and the lessor regarding the rent concession;
  • whether the reason for the rent concession is stated explicitly in the supplementary agreement between the lessor and the lessee or is otherwise apparent – e.g. from other communications; Beware of COVID 19 Rent concessions IFRS accounting
  • the timing of the negotiation and agreement of the rent concession;
  • whether multiple concessions relating to the same lease need to be evaluated individually or in aggregate – i.e. to assess whether they are reasonably linked to the effects of the COVID-19 pandemic and are commensurate;
  • the relevant laws and regulations in the specific jurisdiction; and Beware of COVID 19 Rent concessions IFRS accounting
  • the extent and nature of, and reasons for, government intervention. Beware of COVID 19 Rent concessions IFRS accounting

While a government lock-down may be important evidence that a rent concession is a direct consequence of COVID-19, it is not determinative. Businesses have experienced disruptions both before and after official lock-down periods. Therefore, lessees should consider whether rent concessions agreed to before and/or after an official lock-down are also a direct result of COVID-19.

Worked example – Rent concessions that are a direct consequence of the COVID-19 pandemic

Retailer R in Country X leases several retail stores and a head office building. COVID-19 cases were first identified in X in late March 2020 and R observed decreasing sales in its stores from this point. X’s government introduced lock-down measures in April 2020 and at this point R closed its stores to customers.

R agreed a rent concession for the head office building in January 2020 relating to refurbishment activities undertaken by the landlord that disrupted access to the building. R agreed further rent concessions for the retail stores in May and June 2020.

R elects to apply the practical expedient. In doing so, R notes the following.

  • It cannot apply the practical expedient to the head office building because that rent concession related to access disruption and not to the COVID-19 pandemic. Therefore, the rent concession is not a direct consequence of the COVID-19 pandemic.
  • It can apply the practical expedient to the retail stores provided that the other conditions of the practical expedient are met. This because the rent concession was received after COVID-19 cases were identified and its ability to use the retail stores was directly affected by the COVID-19 lock-down measures.

Revised consideration is substantially the same as or less than the original consideration

Payment deferrals accompanied by increased future lease payments to compensate the lessor for the time value of money do not disqualify the rent concession from the practical expedient. Additionally, a change in rent payments from fixed to variable may be eligible for the practical expedient.

However, ‘short payments’ (i.e. payments of less than the contractually required amount without the lessor’s agreement) do not qualify for the practical expedient until and unless the lessor agrees thereto because no ‘concession’ has been granted.

See the following examples to obtain an illustrated understanding: Beware of COVID 19 Rent concessions IFRS accounting

Worked example – Rent concessions that change the consideration in the lease: Time value of money

Retailer Q leases a store in a large retail mall. The rent payable is 1,000 per month. As a result of the COVID-19 pandemic, Q agrees with the lessor to defer the rent originally due in the months April to June 2020.

As part of this agreement, the rent for the period January to March 2021 will be increased by 1,100 per month, which compensates the lessor for the deferred rent as adjusted for the time value of money.

Q considers applying the practical expedient.

In assessing whether the rent deferral is eligible for the practical expedient, Q notes that the increase in rent is attributable to the time value of money. Therefore, Q concludes that the rent deferral is eligible for the practical expedient if the other conditions are met.

Worked example – Rent concessions that change the consideration in the lease: Administrative fee

Varying on the above example, the rent due in January to March 2021 remains the same – i.e. 1,000 per month. In addition, in April 2020 Retailer Q pays an administrative fee of 50 to the lessor.

In assessing whether the rent deferral is eligible for the practical expedient, Q assesses that the revised consideration is not substantially different from the original consideration. Therefore, Q concludes that the rent deferral is eligible for the practical expedient if the other conditions are met.

Q&A Beware of COVID 19 Rent concessions IFRS accounting

Flash light focusDoes a rent concession that increases the future lease payments to compensate the lessor for the time value of money qualify for the practical expedient?

Yes. If the lease payments are deferred during the COVID-19 pandemic and the deferred payments are increased to compensate the lessor for the time value of money relating to the deferred payments, then these increases do not disqualify the concession from the practical expedient.

Flash light focusAre payment shortfalls not agreed with the lessor eligible for the practical expedient?

Some lessees may decide, or be forced by their cash flow circumstances, to make rent payments that are less than the amount that is contractually owed to the lessor. In some cases, a lessee may intend to pay any shortfalls at a later date or seek forgiveness of the unpaid amounts from the lessor.

If no change has been agreed by the parties – i.e. the lessor has not agreed to accept the payment shortfall either permanently (abatement) or temporarily (deferral) – then no ‘concession’ has been granted by the lessor to the lessee. Therefore, the payment shortfall is not subject to the amendments – i.e. the lessee is not permitted to account for the payment shortfall as if the unpaid amount was a contractual rent reduction for the period to which it relates.

Payments due on or before June 30, 2021

The practical expedient is strictly time-limited and applies only to rent concessions for which any reduction(s) in lease payments affects payments originally due on or before June 30, 2021. Beware of COVID 19 Rent concessions IFRS accounting

For example, a concession that reduces rent payments that were originally due both before and beyond June 30, 2021 does not qualify for the practical expedient in its entirety – i.e. no portion of the concession meets the criterion.

See the following examples to obtain an illustrated understanding: Beware of COVID 19 Rent concessions IFRS accounting

Worked example – Deferral in rent payments that affects payments due after 30 June 2021

Lessee P operates a chain of restaurants and leases several outlets. As a result of the COVID-19 pandemic, P agrees a rent deferral with the lessor.

Under the terms of the rent deferral, rent originally due in the period July to December 2020 will be added to the rent due in the period July to December 2021.

P considers applying the practical expedient.

In assessing whether the rent deferral is eligible for the practical expedient, P notes that the rent deferral affects rent payable until December 2021 but only reduces rents originally due up to December 2020. Therefore, P concludes that the rent deferral meets the ‘payments due’ eligibility criterion.

Worked example – Reduction in rent payments that extends beyond 30 June 2021

Lessee T leases office buildings from a lessor. As a result of the COVID-19 pandemic, in September 2020 T agrees a rent concession with the lessor, under which the monthly rent will be reduced by 50% per month for the 12 months commencing 1 October 2020.

T considers applying the practical expedient.

T notes that this rent concession is not eligible for the practical expedient because it reduces lease payments originally due up to September 2021 – i.e. beyond 30 June 2021. Further, T notes that this means that no portion of the rent concession is eligible for the practical expedient – i.e. T is not permitted to apply the practical expedient to the rent originally due for payment up to 30 June 2021.

Q&A Beware of COVID 19 Rent concessions IFRS accounting

Beware of COVID 19 Rent concessions IFRS accountingWhy is the practical expedient limited to reductions in lease payments originally due on or before 30 June 2021?

This criterion means that the practical expedient is strictly time-limited. The Board considered that a practical expedient without a time limit could potentially lead to broader application and therefore have unintended consequences.

For instance:

  • companies may agree to multiple amendments to lease contracts at once. If the practical expedient is not limited to a timeframe, then companies could potentially apply the practical expedient to amendments in lease contracts that may not be a direct consequence of the COVID-19 pandemic (e.g. future rent reductions intended to induce the entity into a longer-term extension, rather than to help mitigate the economic effects of COVID-19);
  • the economic effects of the COVID-19 pandemic are uncertain and could extend for some time. Therefore, not having a definitive timeframe could lead to companies applying the practical expedient to future changes to the lease contract that are unrelated to the COVID-19 pandemic merely because its economic effects are long-lasting. This would result in companies not applying the lease modification guidance where they otherwise would have; and
  • reduced comparability between companies that elect the practical expedient and companies that do not will arise only for a limited period.

No other ‘substantive’ changes to the lease

The practical expedient is available for a rent concession if no other substantive changes are made to the terms of the lease together with the concession. In considering whether a change is substantive, a lessee needs to consider the contract combination guidance in IFRS 16 if there have been other changes to the lease negotiated at or around the same time.

The basis for conclusions to IFRS 16 (BC205D(c)) indicates that a three-month rent holiday together with a three-month lease extension to make up the lost rent would not constitute a substantive change to the lease. Conversely, a rent-free period granted in exchange for a significant extension of the lease term may constitute a substantive change. Beware of COVID 19 Rent concessions IFRS accounting

Lessees need to exercise judgment when determining whether a rent concession qualifies for the practical expedient. This requires careful consideration of the revised lease terms compared to those of the original contract to ensure that there are no other substantive changes to the lease terms and conditions. Beware of COVID 19 Rent concessions IFRS accounting

Worked example – Deferral of rent payments by extending the lease term

A lessee is granted a rent concession by the lessor whereby the lease payments for the period April to June 2020 are deferred. Three months are added to the end of the lease term at the same monthly rent, and the lessee repays the deferred rent during those additional months. The rent concession is a direct consequence of COVID-19.

The lessee considers applying the practical expedient.

In considering whether this rent concession is eligible for the practical expedient, the lessee notes the following.

Firstly, the revised consideration in the lease is substantially the same as the original – i.e. the condition in paragraph 46B(a) of IFRS 16 is met.

Secondly, the rent concession only reduces lease payments originally due in 2020 – i.e. before 30 June 2021 – so the condition in paragraph 46B(b) of IFRS 16 is met.

Thirdly, there is a change in the lease term – an extension by three months. This is a change to the terms and conditions of the lease. The lessee assesses whether this change in lease term is substantive and concludes that it is not – i.e. the condition in paragraph 46B(c) of IFRS 16 is met.

Because the rent concession is a direct consequence of COVID-19 and all three conditions in paragraph 46B of IFRS 16 are met, the lessee concludes that the rent concession is eligible for the practical expedient.

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IFRS 16 Rent concession amendments in a nutshellWhat are other substantive changes to the lease contract?

A company assesses whether there are changes to other terms and conditions in the lease contract that are not a direct consequence of the COVID-19 pandemic – i.e. those for which the practical expedient does not apply. This includes lease modifications that are negotiated at or around the same time as a rent concession relating to COVID-19.

Lease modifications ‘negotiated at or around the same time’ may include multiple concessions granted for the same lease but agreed at different times or formalised in separate legal documents. For example, as the crisis continues a rent deferral may be followed by a further deferral or an abatement. When determining whether there has been a substantive change to the lease, a lessee needs to consider the contract combination guidance in IFRS 16 to evaluate whether to aggregate multiple concessions or to evaluate them separately.

The term ‘substantive’ has not been defined in the amendments, but this may not result in significant diversity in practice given the other eligibility criteria for the practical expedient. For example, defining ‘substantive’ precisely will not be necessary if the lessee concludes that the change in question is not a direct consequence of the COVID-19 pandemic or fails either the ‘total consideration’ or ‘payments due’ criteria. In all cases, a lessee is expected to make the judgement about whether other changes are substantive based on its understanding of those changes.

IFRS 16 Rent concession amendments in a nutshellDoes a change in rent payment from fixed to variable fail the ‘no substantive change to other terms and conditions’ criterion?

Not necessarily. A rent concession granted to a lessee can take different forms. For example, a retailer may agree that fixed rent for a retail store will be replaced by a variable rent that depends on the sales at the retail store for a period of time. This may be a fixed period (e.g. a fixed number of months) or an indeterminate period (e.g. until temporary COVID-19-related measures cease). In some cases, the variable rent may be explicitly capped at the original fixed amount or may be expected to be lower than the original fixed amount.

In these cases, the change in rent from fixed to variable for a period of time is a rent concession and is eligible for the practical expedient if the other eligibility criteria are met.

Applying the practical expedient – Intro

Rent concessions arising directly from the COVID-19 pandemic are not accounted for as lease modifications.

The amendments permit lessees, as a practical expedient, not to assess whether rent concessions relating to the COVID-19 pandemic are lease modifications. Beware of COVID 19 Rent concessions IFRS accounting

Instead, these lessees account for those rent concessions under other guidance in the standard, as set out in the following flowchart.

IFRS 16 amendments Corona Rent concessions

Apply the practical expedient (see below) Go to – Lease modification accounting

The IFRS 16 amendments do not include application guidance on applying the practical expedient; instead they refer to the standard’s existing requirements. The accounting for a rent concession will depend on the specifics of the relief.

One-off reductions or forgiveness in rent will generally be recorded as a negative variable lease payment and recognized in profit or loss – i.e. debit lease liability; credit variable lease expense. The lessee should continue to accrue interest on the reduced lease liability at the unchanged incremental borrowing rate – i.e. debit interest expense; credit lease liability. Beware of COVID 19 Rent concessions IFRS accounting

When lease payments are only deferred, it may be acceptable to either: Beware of COVID 19 Rent concessions IFRS accounting

  • remeasure the lease liability using an unchanged discount rate and recognize the difference between the original lease liability and the updated lease liability as variable lease expense; or Beware of COVID 19 Rent concessions IFRS accounting
  • separate the deferred portion of the lease liability into a separate payable not subject to interest, while continuing to account for the remainder of the lease liability as before the concession (i.e. subject to interest).

Lessees electing to apply the practical expedient must provide the new disclosures introduced by the amendments in addition to IFRS 16’s existing disclosures. Ultimately, the extent of additional disclosure is company-specific and the company should communicate with the aim to provide useful information to investors and other stakeholders. Beware of COVID 19 Rent concessions IFRS accounting

Is a company required to apply the practical expedient to rent concessions relating to the COVID-19 pandemic?

No; applying the practical expedient is optional.

Many lessees will be attracted by the practical relief offered by the amendments. The practical expedient reduces the effort and subjectivity involved in assessing whether eligible rent concessions are lease modifications. It also avoids some of the complexities involved in lease modification accounting.

However, some lessees may prefer to apply the standard’s existing requirements to all changes in lease contracts. This would increase the comparability between the accounting for rent concessions that do and do not qualify for the practical expedient. It would also enhance comparability year-on- year – e.g. if the lessee expects to have rent concessions in future years.

References: IFRS 16.2, IFRS 16.36 – 46, IFRS 16 BC205C

Is a company that elects to apply the practical expedient required to apply it to all eligible rent concessions?

No. However, lessees are required to apply the practical expedient consistently to contracts with similar characteristics and in similar circumstances. This is consistent with the standard’s existing requirements.

For example, a retailer may lease a large portfolio of retail stores and lease a fleet of vehicles that it uses for distribution. Depending on the facts and circumstances, it is possible that the retailer may conclude that it is acceptable to:

  • apply the practical expedient consistently to eligible rent concessions relating to leases of its retail stores; and
  • account for rent concessions relating to its vehicle leases by applying the standard’s existing lease modification guidance.

Depending on the facts and circumstances, it is also possible that the retailer may conclude that it is acceptable to:

  • apply the practical expedient consistently to rent concessions that forgive a portion of rent to which the lessor is entitled; and
  • account for rent deferral concessions by applying the standard’s existing requirements.

If the retailer applies the practical expedient to rent concessions granted only for its retail store leases or rent forgiveness concessions, rather than all of its eligible rent concessions, then it discloses information about the nature of the leases to which it has applied the practical expedient.

References: IFRS 16.2, IFRS 16.60A (a), IFRS 16 BC205C

Applying the practical expedient

– Forgiveness of lease payments

One common form of rent concession arising from the COVID-19 pandemic is lessors offering rent-free periods or ‘rent holidays’ to their lessees, with no other changes to the lease (IFRS 16.BC205E(a)). Beware of COVID 19 Rent concessions IFRS accounting

Worked example – Unconditional forgiveness of lease payments

Lessee Z entered into a lease contract with Lessor L to lease 1,500m2 of retail space for five years. The lease commenced on 1 January 2018 and the rental payments are 100,000 payable quarterly in advance on 1 January, 1 April, 1 July and 1 October. Z’s incremental borrowing rate at commencement of the lease is 5% (assume that the interest rate implicit in the lease cannot be readily determined). There are no initial direct costs, lease incentives or dismantling costs.

Z’s business is severely impacted by the COVID-19 pandemic and L and Z negotiate a rent concession. On 1 June 2020, L agrees to provide Z with an unconditional rent concession that allows Z to forego payment of its rent due on 1 July – i.e. L forgives Z the rent payment of 100,000 due on 1 July.

Z determines that the rent concession is eligible for the practical expedient.

In determining how to account for the rent concession, Z notes that it results in a forgiveness of rent. Applying the practical expedient, Z accounts for this forgiveness of rent as a negative variable lease payment. Z notes that the rent concession is unconditional and so the event that triggers the variable lease payment is Z and L agreeing the rent concession on 1 June 2020.

Therefore, Z accounts for the rent concession as a negative variable lease payment on 1 June.

Assuming that there are no other changes to the lease, Z continues to use the retail space and the right-of-use asset is not impaired, then the lease accounting entries will be as follows:

  • recognise the rent concession as a variable lease payment in profit or loss (i.e. record a debit to the lease liability and a corresponding credit in the income statement); and
  • continue to accrue interest on the lease liability at the unchanged incremental borrowing rate of 5% (i.e. record a debit to interest expense and a corresponding credit to the lease liability).

After accounting for the impact of the rent concession, Z’s lease liability represents the present value of all future lease payments owing to L, discounted at the unchanged incremental borrowing rate. Z has effectively derecognised the portion of the lease liability that has been extinguished by the forgiveness of the quarterly lease payment due on 1 July 2020.

In addition, Z continues to depreciate the carrying amount of the right-of-use asset, which is unchanged as a result of the rent concession.

Reference: IFRS 16.38, IFRS 16.46A, IFRS 16.46B, IFRS 16 BC205D–BC205F, IFRS 9.3.3.1

Worked example – Conditional forgiveness of lease payments

Assume the same facts as Example 6A, except that on 1 June, Lessor L agrees to a conditional rent concession that allows Lessee Z to forego paying the rent due on 1 July if the government lock-down remains in place at that date. If the government does continue the lock-down, then the rent of 100,000 due on 1 July will be forgiven. Otherwise, this amount will remain payable when it is due.

The government lock-down remains in place on 1 July and triggers the conditional rent concession – i.e. the forgiveness of the rent due on 1 July.

As such, Z accounts for a negative variable lease payment on 1 July.

Assuming that there are no other changes to the lease, Z continues to use the retail space and the right-of-use asset is not impaired, then the lease accounting entries will be as follows:

  • recognise the rent concession as a negative variable lease payment in profit or loss on 1 July (i.e. record a debit to the lease liability and a corresponding credit in the income statement); and
  • continue to accrue interest on the lease liability at the unchanged incremental borrowing rate of 5% (i.e. record a debit to interest expense and a corresponding credit to the lease liability).

After accounting for the impact of the rent concession, Z’s lease liability on 1 July represents the present value of all future lease payments owing to L, discounted at the unchanged incremental borrowing rate. Z has effectively derecognised the portion of the lease liability that has been extinguished by the forgiveness of the quarterly lease payment due on 1 July 2020.

In addition, Z continues to depreciate the right-of-use asset.

Reference: IFRS 16.38, IFRS 16.46A, IFRS 16.46B, IFRS 16 BC205D–BC205F, IFRS 9.3.3.1

Worked example – Conditional rent abatement

Lessee C leases retail premises for five years for fixed monthly payments of 10,000 due at the beginning of each month. Due to the COVID-19 pandemic, C has been prevented by the government from opening its premises to the public.

As a result, on 1 April 2020 Lessor D provides a rent concession whereby no rent is payable for each of the months April, May and June 2020, provided that, on each monthly due date, the government ruling remains in force and public access to C’s premises is restricted. There are no other changes to the terms and conditions of the lease and the government restrictions remain in place until the end of June 2020.

C determines that the rent concession is granted as a direct consequence of the COVID-19 pandemic and qualifies for the practical expedient. Therefore, C does not assess whether the change is a lease modification and can elect to account for the monthly abatements as negative variable lease payments.

In this case, the right to the abatement each month is subject to meeting a condition at the beginning of that month – i.e. whether the government’s restrictions remain in place.

As a result, C derecognises a portion of the lease liability and recognises a negative variable lease payment in each month.

References: IFRS 16.38(b), IFRS 16.46A, IFRS 16.46B

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Corona Rent concessions IFRS accountingWhat is the ‘event or condition’ that triggers the variable lease payments?

Identifying the event or condition that triggers the variable lease payment is a key driver of how and when to account for a rent concession in such cases.

This may depend on the facts and circumstances of the rent concession. There appear to be two main scenarios.

The first possibility is that the granting of the rent concession is the event or condition. This may be the case if, for example, the rent concession, once it is agreed, is entirely unconditional. When granting the rent concession is the event or condition:

  • the lessee recognises the benefit of the rent concession as a variable lease payment in profit or loss when the rent concession is granted; and
  • the amount of the variable lease payment recognised will not necessarily equal the nominal (cash) amount of the rent reduction, due to the effect of discounting.

The second possibility is that the rent concession, once it is granted, remains conditional. For example, the lessee will receive the benefit of the rent concession at each payment date only if it has complied with other conditions or prescribed conditions exist – e.g. those described in worked examples ‘Conditional forgiveness of lease payments’ and ‘Conditional rent abatement’. When this is the case:

  • the lessee recognises the benefit of the rent concession as a variable lease payment in profit or loss as and when the conditions are met; and
  • if the conditions are tested at each payment date, the amount of the variable lease payment recognised will equal the nominal (cash) amount of the rent reduction – i.e. there will be no discounting effect.

Although the duration of the COVID-19 pandemic and its economic effects may be unknown, this does not automatically lead to a concession granted being conditional. Instead, conditionality arises if a concession is dependent on a specific circumstance occurring – e.g. where the rent forgiveness extends from month to month only if temporary COVID-19 lock-down measures remain in force for that month.

Reference: IFRS 16.38 (b)

Deferral of lease payments

Another common type of rent concession being negotiated during the COVID-19 pandemic is the deferral of lease payments. The concession granted may involve the reduction of lease payments in some periods with an increase in payments in other periods.

When a rent concession involves deferred lease payments only, the lessee accounts for the change by recognising the impact in the period when no payment is made by continuing to reduce the lease liability.

Worked example – Deferral of lease payments

Lesse Z enters into a lease contract with Lessor L for a retail space for two years. The lease commences on 1 March 2020 and the rental payments are 2,000 per month payable in advance. The incremental borrowing rate at commencement of the lease is 6% and the interest rate implicit in the lease cannot be readily determined. There are no initial direct costs, lease incentives of dismantling costs.

Z records a right-of-use asset of 45,351¹ and the lease liability of 45,351¹ at the commencement date as follows:

Beware of COVID 19 Leases rent concessions IFRS accounting

Note

1. Lease liability is calculated as the present value of future lease payments over two years, discounted at 6%. Right-of-use asset is calculated as 45,351, which is the initial measurement of the lease liability of 43,351 + rent paid at commencement of 2,000.

Z’s business has since been severely impacted by the COVID-19 pandemic. Z negotiates a rent concession with L in May 2020 – the advance payment for June 2020 is deferred, interest-free, and will instead be paid over the remaining 20 months of the lease term (100 per month, resulting in each remaining monthly payment equalling 2,100). To facilitate the rent concession, other non-substantive changes are made to the lease contract.

Z determines that the rent concession is a direct consequence of the COVID-19 pandemic and qualifies for the practical expedient.

The rent concession is unconditional, notwithstanding the fact that the duration and impact of the COVID-19 pandemic are unknown.

In this case, the original rent payable in May 2020 has been deferred, not forgiven. Therefore, Z does not account for a negative variable lease payment or a partial derecognition of the lease liability for the rent of 2,000 that is deferred.

One acceptable approach is for Z to account for the rent deferral as if Z is entitled to the deferral under the existing terms and conditions of the lease. Z remeasures the lease liability using the revised timing of the lease payments and an unchanged discount rate of 6%. Z recognises the impact of the change in the present value of the lease liability in profit or loss on the date the rent concession is effective.

Beware of COVID 19 Rent concessions IFRS accounting

Notes

  1. Payments for June 2020 to February 2022 are adjusted for the May 2020 deferral also being paid (2,000 original monthly payment + 100 deferral payment).

  2. The impact of remeasuring the lease liability is recognised in profit or loss (i.e. record a debit to the lease liability and a corresponding credit in the income statement).

  3. At the end of May 2020, the lease liability is remeasured to 39,874, which equals the present value of the remaining 20 lease payments, discounted at Z’s unchanged incremental borrowing rate of 6%.

Another acceptable approach is for Z to account for the rent deferral by adjusting the timing of the future cash flows and, in effect, bifurcating the lease liability into two portions – one portion (based on the original payment schedule) that remains subject to interest and one that is not (the ‘interest-free’ deferral).

This is necessary for the lease liability to amortise to zero by the end of the lease term.

Under this approach, there is no remeasurement of the lease liability. The carrying amount of the lease liability at the end of each month during the lease term is as follows.

Beware of COVID 19 Rent concessions IFRS accounting

Notes

  1. Z does not recognise accrued interest on the deferred payment balance. Interest is accrued as if no change in the timing of cash flows has occured.

  2. Payments for June 2020 to February 2022 are adjusted for the May 2020 deferral also being paid (2,000 original monthly payment + 100 deferral payment).

References: IFRS 16.36, IFRS 16.46A – B, BC205D–BC205F

Beware of COVID 19 Rent concessions IFRS accountingDoes a lessee suspend depreciation of its right-of-use asset during the COVID-19 pandemic if it cannot use the underlying asset as originally intended?

No. Lessees depreciate right-of-use assets in accordance with IAS 16 Property, Plant and Equipment. IAS 16 notes that depreciation does not cease when an asset becomes idle.

In many cases, lessees have had to severely curtail their operations and their use of leased assets as a result of the COVID-19 pandemic. For example, retailers have closed leased retail stores to the public and airlines have reduced flight schedules dramatically for their leased aircraft.

However, if the lessee retains the right to use the underlying asset, albeit in a restricted manner – e.g. a retailer that can only use a leased retail store to hold inventory and fulfil online orders – then the lessee continues to depreciate the right-of-use asset.

The lessee applies IAS 36 Impairment of Assets to determine whether its right-of-use asset is impaired and to account for any impairment. After the recognition of an impairment loss, the future depreciation charges for the right- of-use asset are adjusted to reflect the revised carrying amount.

References: IFRS 16.31, 33, IAS 16.55

No relief for lessors

The practical expedient does not apply to lessors. Instead, lessors are required to assess whether rent concessions are lease modifications and, if so, to apply the lessor lease modification guidance in IFRS 16.

The IFRS 16 and US GAAP practical expedients: same objectives, different outcomes

The FASB staff issued guidance (practical expedient) addressing COVID-19 related lease concessions accounted for under the new (ASC 842) and legacy (ASC 840) lease standards.

Like IFRS® Standards, absent this relief, companies with COVID-19 related rent concessions would need to assess the enforceable rights and obligations in the original lease contract to determine how to account for the concession. The practical expedient allows companies (lessees and lessors under US GAAP) to forgo such assessment.

Under the practical expedient, companies can elect to account for COVID-19 related rent concessions either:

  • as if the revised rent was required under the original contract; or
  • as a lease modification (which is not permitted as an option under IFRS 16).

The practical expedient is more permissive with respect to eligibility than that of IFRS Standards. It does not require either (1) that the concession be a direct consequence of COVID-19 (merely that it be related to COVID-19) or (2) that any reduced payments be only through June 30, 2021.

Unlike IFRS Standards, the practical expedient includes guidance on acceptable accounting approaches for certain types of concessions (e.g. rent deferrals).

Is the practical expedient the right choice for your company?

Though the practical expedient is expected to provide relief to lessees, particularly to those with a large portfolio of leases receiving rent concessions, it does not take away all analysis and judgment.

It may also increase volatility in the income statement. This may reduce the comparability of profit and other key indicators that companies normally use for analyzing year-on-year performance. Additionally, the comparability of performance measures for many lessees in similar businesses or sectors will decrease because not all lessees will elect to apply the practical expedient or necessarily apply it in the same manner.

Electing to apply the practical expedient may involve re-configuring systems and updating existing processes. Companies should weigh the costs involved in making changes to systems and processes against the potential benefits of doing so. This may be especially relevant if, for example, a company obtains substantially similar rent concessions but only some qualify for the practical expedient because of the strict time criterion.

Companies need to decide whether to early adopt the practical expedient in any financial statements that are yet to be authorized. This will depend on the volume of leases and the significance of the rent concessions received.

The takeaway

While the practical expedient brings welcome relief for lessees, lack of convergence with US GAAP on the topic may create challenges for some dual reporters, especially lessors who do not get any relief under IFRS Standards.

In addition, the impacts of COVID-19 on lease accounting are not limited to rent concessions. For example, judgments and expectations may have to be reassessed in areas like lease renewal, termination and purchase options. Lessees may have to focus on the impairment analysis for right-of-use assets and lessors may have to consider the recoverability of lease receivables and impairment of their underlying assets.

Disclosures

The introduction of the practical expedient for lessees will have an impact on the comparability of financial statements. IFRS 16 and other standards – e.g. IAS 1 Presentation of Financial Statements – require lessees to disclose information that allows users of financial statements to assess the effect that leases have on their financial position, financial performance and cash flows (IFRS 16.2, IFRS 16.46B, IFRS 16.51 – IFRS 16.60A, IFRS BC205F–BC205G, IAS 7.44A).

In addition to the standard’s existing disclosure requirements, the amendments require a lessee applying the practical expedient to disclose:

  • that it has applied the practical expedient to all rent concessions that meet the conditions; or

  • information about the nature of the leases and/or concessions to which it has applied the practical expedient if it has not applied the practical expedient to all rent concessions that meet the conditions.

The lessee also discloses the amounts recognised in profit or loss for the reporting period to reflect changes in lease payments arising from rent concessions that meet the conditions of the practical expedient.

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The impact of reduced or no cash outflows for leases during the period of the rent concession will affect the disclosure of cash flows in a company’s statement of cash flows. If the rent concession results in the adjustment of the carrying amount of the lease liability, then the lessee discloses this as a non-cash change in lease liabilities when disclosing changes in liabilities arising from financing activities under IAS 7.

Flash light focusAre lessees applying the practical expedient required to disclose the quantitative information required by paragraph 28(f) of IAS 8 on adoption of the amendments?

No; the disclosures required when applying the practical expedient are set out above. Lessees are specifically exempt from the requirement to disclose the information usually required by paragraph 28(f) of IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors when a company changes an accounting policy. This reduces the burden on lessees in the reporting period in which they first apply the amendments.

References: IAS 8.28(f), IFRS 16.C20B

Flash light focusAre there other disclosures that a lessee should make about its accounting for rent concessions under the amendments?

Yes. As outlined above (in ‘Applying the practical expedient’), there may be multiple acceptable approaches to accounting for some types of concessions under the practical expedient.

Therefore, in addition to disclosing its election to apply the practical expedient, a lessee considers the need to disclose how it is applying the practical expedient to different types of leases and rent concessions.

Also read: IFRS Community – Lease modifications

Beware of COVID 19 Rent concessions IFRS accounting Beware of COVID 19 Rent concessions IFRS accounting

Beware of COVID 19 Rent concessions IFRS accounting Beware of COVID 19 Rent concessions IFRS accounting

Beware of COVID 19 Rent concessions IFRS accounting Beware of COVID 19 Rent concessions IFRS accounting

Beware of COVID 19 Rent concessions IFRS accounting Beware of COVID 19 Rent concessions IFRS accounting

Beware of COVID 19 Rent concessions IFRS accounting Beware of COVID 19 Rent concessions IFRS accounting

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Something else -   IFRS 16 Leases and joint arrangements

Beware of COVID 19 Rent concessions IFRS accounting

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