Landlord Lease modifications

Landlord Lease modifications / Rental modifications

Accounting for lease modifications has become a hot topic due to the COVID-19 pandemic, with many tenants seeking rent concessions and other changes to lease agreements.

Unlike IAS 17, IFRS 16 provides detailed guidance on the lessor accounting for lease modifications, with separate guidance for modifications to finance leases and operating leases.

A lease modification is a change in the scope of a lease, or the consideration for a lease, that was not part of its original terms and conditions. Common examples are:

  • decreasing the scope of the lease by removing the right to use one or more underlying assets;
  • decreasing the scope of the lease by shortening the contractual lease term; and
  • changing the consideration in the lease by increasing or decreasing the lease payments.

Changes that result from renegotiations of the original contract are lease modifications.

The exercise of an option included in the original lease contract is not a modification. There is no lease modification when a lessor reassesses the lease term if:

  • the lessee exercises an option not previously included in the lessor’s determination of the lease term;
  • the lessee does not exercise an option previously included in the lessor’s determination of the lease term;
  • an event occurs that contractually obliges the lessee to exercise an option not previously included by the lessor; or
  • an event occurs that contractually prohibits the lessee from exercising an option previously included by the lessor (see Changes in the lease term).

The following diagram summarises the accounting for lease modifications by a lessor/landlord.

Original lease is a finance lease

Change to contractual terms and conditions

Original lease is an operating lease

Increase in scope of lease by adding right of use for one or more underlying assets and at stand-alone price for increase

All other contract modifications.

Classification at inception if modification had been in effect then as:

Operating lease

Finance lease

Separate lease

Not a separate lease

Apply IFRS 9

Modifications to operating leases

Food for thought – When does a lessor account for a lease modification?

Similar to a lessee, a lessor accounts for modifications to operating and finance leases on the effective date of the modification. This is the date when both parties agree to the lease modification. (IFRS 16.79–80, IFRS 16.87)

Food for thought – Is a single, one-off cash payment from a landlord a variable lease payment or a lease modification?

For example, assume a scenario where, as a result of significantly reduced footfall in a shopping mall due to economic factors, a landlord and tenant negotiate short-term relief for the tenant. As a result, the landlord agrees to make a one-off cash payment to the tenant.

Assume that this payment was not contemplated in the terms and conditions of the original contract entered into at lease commencement, and the written contract is not changed as a result of the renegotiation. There are no other changes to the terms and conditions of the contract.

The one-off payment is a reduction in the consideration that was not included in the original terms and conditions of the contract. Therefore, it is a lease modification and not a variable lease payment. Therefore, the landlord applies IFRS 16.79-80 for a finance lease or paragraph 87 for an operating lease.

1 Modifications to operating leases – General considerations

A lessor accounts for a modification to an operating lease as a new lease from the effective date of the modification. As part of the lease payments for the new lease, it considers any prepaid or accrued lease payments relating to the original lease. (IFRS 16.87)

A lessor recognises lease income on a systematic basis that is representative of the pattern in which the benefit of the underlying asset is diminished. This pattern of income recognition reflects the lessee’s right to use the asset.

Case – Landlord modifications to operating leases

Landlord Y enters into a five-year lease with Tenant X for office space. Y classifies this lease as an operating lease because it does not transfer substantially all of the risks and rewards incidental to ownership of the office space to X.

The lease agreement specifies a starting rent of 100,000 payable in arrears and requires the lease payments to be increased by 2% per annum – i.e. 520,404 for the five-year period. X does not provide any residual value guarantee. There are no initial direct costs, lease incentives or other payments between X and Y.

The accounting for lease payments on a straight-line basis is performed by first determining the annual rental income of 104,081 (520,404 / 5), which takes into account the annual indexation. Therefore, Y accounts for the lease payments for the first two years as follows.

Year

Lease payment (A)

Annual rental income (B)

Accrual period end balance (C)

Year 1

100,000

104,081

4,081

Year 2

102,000

104,081

6,182

Due to high vacancy rates in the real estate market, Y would like to encourage X to commit to staying in the office space for longer. At the beginning of Year 3, Y and X enter into negotiations and agree to:

  • extend the original lease of the floor of office space by an additional three years after Year 5; and
  • fix the annual payments for the original lease at 105,000 payable in arrears for the remaining six years (i.e. three years on the initial five-year term plus a three-year extension).

The change in consideration and the extension of the lease term were not part of the original terms and conditions of the lease and are therefore lease modifications. Y accounts for these modifications as a new operating lease from the effective date of the modifications. This takes into account accrued lease payments relating to the original lease payments as follows.

Year

Lease payment (A)

Annual rental income (B)¹

Accrual period end balance (C)

Year 3

105,000

103,973

5,135

Year 4

105,000

103,973

4,108

Year 5

105,000

103,973

3,081

Year 6

105,000

103,973

2,054

Year 7

105,000

103,973

1,027

Year 8

105,000

103,973

Note
1. B = sum of A (lease payments) / 6 – (C at end of Year 2) / 6 (remaining lease term). B = (105,000 × 6) / 6 – 6,162 / 6 = 103,973.

2. Modifications to operating leases related to COVID-19

Due to the impact of the COVID-19 pandemic on business conditions, many lessees are seeking rent concessions from lessors. The Board has issued amendments to IFRS 16 to simplify how lessees account for rent concessions. (IFRS 16.87, IFRS 16.BC240A)

Lessors are required to assess whether a rent concession granted during the COVID-19 pandemic is a lease modification. (IFRS 16.BC240A) If a lessor concludes that a rent concession is a lease modification, then it applies the specific guidance in the standard on accounting for lease modifications.

A lessor accounts for a modification to an operating lease as a new lease from the effective date of the modification. (IFRS 16.87)

Occasionally a lessee terminates a lease earlier than the term contemplated in the original agreement and pays the lessor a termination penalty (which results from negotiation between the lessee and the lessor when they reach a modified agreement). It appears that these termination penalties should be considered part of the revised lease payments.

Case – Decrease in scope and consideration: Lease modification

Landlord L leases retail space to Tenant Z for five years and classifies the lease as an operating lease. The lease commences in June 2018 and includes fixed lease payments of 10,000 per month, which increase by 2% per annum.

L accounts for the lease payments on a straight-line basis by first determining the annual rental income of 124,897 (624,485 / 5), which takes into account the annual increase.

Date

Lease payment

Landlord Lease modifications
Lease shirt

2018

120,000

2019

122,400¹

2020

124,848¹

2021

127,345¹

2022

129,892¹

Total

624,485

Note
1. Includes 2% increase per annum.

L accounts for the lease payments in 2018 and 2019 as follows.

Period

Lease payment (A)

Annual rental income (B)

Accrual period end balance (C)

June 2018 – May 2019

120,000

124,897

4,897

June 2019 – May 2020

122,400

124,897

7,394¹

Note
1. C = C prior year + (B − A).

Z’s business has since been severely impacted as a result of the COVID-19 pandemic. Therefore, at the beginning of June 2020, L and Z agree to reduce the space from 1,500m2 to 1,000m2.

L and Z also agree to reduce the lease payments to a fixed amount of 90,000 per annum, payable in arrears for the remaining three years.

The decreases in scope (retail space) and consideration were not included in the original terms and conditions of the lease and are therefore a lease modification. L accounts for this modification as a new operating lease from the effective date of the modification. This takes into account accrued lease payments relating to the original lease as follows.

Period

Lease payment (A)

Annual rental income (B)¹

Accrual period end balance (C)

June 2020

90,000

87,535

4,929

June 2021

90,000

87,535

2,464

June 2022

90,000

87,536

Something else -   Onerous

Case – Unamortised lease incentive: Lease modification

Landlord M enters into a 10-year lease of office space with Tenant K, which commences on 1 April 2015. The rental payments are 15,000 per month, payable in arrears. M Landlord Lease modificationsclassifies the lease as an operating lease. M reimburses K’s relocation costs of 600,000, which M accounts for as a lease incentive. The lease incentive is recognised as a reduction in rental income over the lease term using the same basis as for the lease income – in this case, on a straight-line basis over 10 years.

On 1 April 2020, during the COVID-19 pandemic, M agrees to waive K’s rental payments for May, June and July 2020.

This decrease in consideration is not included in the original terms and conditions of the lease and is therefore a lease modification.

M accounts for this modification as a new operating lease from its effective date – i.e. 1 April 2020. M recognises the impact of the waiver on a straight-line basis over the five-year term of the new lease. M also takes into account the carrying amount of the unamortised lease incentive on 1 April 2020 of 300,000.

M amortises this balance on a straight-line basis over the five-year term of the new lease.

Case – Termination/break of the lease not included in original contract

Landlord M enters into a 10-year contract with Tenant L to lease a building. There are no termination or break clauses in the original contract.

M classifies the lease as an operating lease.

During Year 5, L begins experiencing financial difficulties and wants to end the lease earlier than originally planned. At the end of Year 5, M and L enter into negotiations and agree to terminate or break the lease at the end of Year 7 (i.e. in two years’ time, three years earlier than the original expiry of the lease).

L agrees to pay M a termination or break fee. M and L also agree to reduce the lease payments for the remaining term until the end of Year 7.

IFRS 16.87 The original terms and conditions of the lease did not include an option to terminate or break the lease, reduce the lease term or reduce lease payments. Therefore, M treats this as a modification to an operating lease. That is, M treats the modification as a new lease from the effective date of the modification, considering any prepaid or accrued lease payments relating to the original lease as part of the lease payments for the new lease.

In this case, the lease contains only a single lease component; therefore, the termination or break fee forms part of the revised lease payments.

Food for thought – What other matters does an operating lessor consider when there is a change to the scope or consideration of a lease during the COVID-19 pandemic?

An operating lessor assesses whether the underlying asset and related balances are measured appropriately.

The lessor applies IAS 36 if the underlying asset is:

  • property, plant and equipment;
  • a right-of-use asset that is not investment property; or
  • investment property measured at cost.

If the underlying asset is investment property measured at fair value, then the lessor will need to ensure that the fair value reflects the revised terms of the in-place leases and the current expectations of market participants for the value of the property.

In addition, the lessor applies the impairment requirements of IFRS 9 to operating lease receivables. For example, if a lessee does not pay the lease payments due to financial difficulties, then the lessor will recognise a loss allowance for expected credit losses on the operating lease receivable in accordance with IFRS 9.

Food for thought – Can a lessor capitalise incremental initial direct costs incurred as a result of a modification to an operating lease?

Yes. IFRS 16 defines initial direct costs as “incremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained”. Considering that IFRS 16 requires a lessor to account for an operating lease modification as a new lease, incremental costs incurred can be capitalised.

Food for thought – How should a lessor account for a lease incentive when it waives lease payments for a portion of the lease?

Assume that a lessor in an operating lease has recognised a lease incentive asset for its initial contribution to the lessee’s leasehold improvements. The lease incentive is amortised over the lease term.

When a lessor agrees to waive rental payments – e.g. for the next three months – the question arises whether a proportionate amount of the lease incentive should be derecognised.

Assume that there are no terms in the original lease that could contractually have given rise to the waiver of lease payments. Therefore, the waiver of lease payments is a lease modification. IFRS 16.87 provides guidance on the accounting for a modification to an operating lease.

Under IFRS 16.87, prepaid lease payments relating to the original lease are considered part of the lease payments for the new lease. Therefore, no portion of the lease incentive is derecognised.

3 Changes to operating leases that are not lease modifications

Changes in lease payments that result from terms in the original lease contract or in applicable law or regulations are part of the original terms and conditions of the lease, even if the effect of those clauses was not previously considered. If there is no change in either the scope of or the consideration for a lease, then there is no lease modification and IFRS 16’s other requirements are applied. (IFRS 16.81)

Case – Deferral of lease payments not a lease modification

Landlord L leases retail space to Tenant Z and classifies the lease as an operating lease. The lease includes fixed lease payments of 10,000 per month.

Due to the COVID-19 pandemic, L and Z agree on a rent concession that allows Z to pay no rent in the period from July to September 2020 but to pay rent of 20,000 per month in the period from January to March 2021. There are no other changes to the lease.

L determines that the reduction in lease payments in July to September 2020 and the proportional increase in January to March 2021 do not result in an overall change in the consideration for the lease.

L does not account for the change as a lease modification. L continues to recognise operating lease income on a straight-line basis, which is representative of the pattern in which Z’s benefit from use of the underlying asset is diminished.

Food for thought – Is a rent deferral that increases the future lease payments a lease modification?

Not necessarily.

The Board’s document notes that if lease payments are deferred during the period of the COVID-19 pandemic and are subsequently increased ‘proportionally’, then the consideration for the lease is unchanged. In the absence of other changes to the lease, this means that there is no lease modification.

The Board’s document does not elaborate on the meaning of the term ‘proportionally’ and the amendments do not use the term. This means that lessors will need to determine an appropriate definition of the term and apply it consistently.

For example, 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 the lessor assesses whether the lease payments have been increased ‘proportionally’.

Food for thought – What are the accounting implications for the landlord if a tenant does not make rent payments when they are due?

As discussed previously, a lease modification is a change to the terms and conditions of the lease. If the tenant fails to pay amounts due under the lease contract with no agreement with the landlord, then this is not a lease modification. (IFRS 16.76, IFRS 16.77, IFRS 16.81)

Instead, the landlord will continue to account for the lease under its original terms and conditions unless and until the landlord agrees to modify the contract.

However, if the tenant fails to pay amounts due under the lease contract, or the landlord is otherwise concerned that the tenant may be unable to pay amounts falling due in future periods, then there are a range of other issues that the landlord needs to consider.

For operating leases, these issues include but are not limited to the following.

  • Income recognition: Operating lease income reflects the rental payments to which the landlord is entitled under the enforceable terms and conditions of the lease. In addition, the landlord will need to assess whether it remains appropriate to recognise income from non-lease components – e.g. maintenance income under IFRS 15.
  • Carrying amount of the underlying asset: Landlords will need to ensure that the underlying asset is appropriately measured. For investment property measured at fair value, this will include ensuring that the fair value reflects current market participant expectations about in-place leases and residual values. For other underlying assets, this will include considering whether there is a trigger for impairment testing.
  • Lease receivables: Operating lease receivables are subject to impairment testing under IFRS 9.

Example

Landlord L leases a store to a retailer for fixed lease payments of 100 per month. L classifies the lease as an operating lease. For the last six months of 2020, due to financial difficulty, the retailer pays only 50 per month, with the intention to repay the balance in 2021. No modification agreement is signed between the landlord and the tenant.

L recognises revenue of 1,200 for 2020, collects 900 and records a receivable of 300. The lease receivable is subject to impairment testing under IFRS 9.

Finance lease

In a finance lease, although the landlord will continue to account for the lease under its original terms and conditions, the carrying amount of the net investment in the lease and interest income related thereto may be impacted. The landlord applies IFRS 9’s impairment requirements to the net investment in the lease and regularly reviews the estimated unguaranteed residual values used in computing the gross investment in the lease. The landlord applies IFRS 16 to recognise reductions in the unguaranteed residual value of the underlying asset.

Something else -   IFRS 15 Contracts with customers

Food for thought – Should a landlord continue to recognise operating lease income on a straight-line basis if the tenant’s business is impacted by COVID-19 or government restrictions?

Assume that a lessor in an operating lease has recognised a lease incentive asset for its initial contribution to the lessee’s leasehold improvements. The lease incentive is amortised over the lease term.

When a lessor agrees to waive rental payments – e.g. for the next three months – the question arises whether a proportionate amount of the lease incentive should be derecognised.

Assume that there are no terms in the original lease that could contractually have given rise to the waiver of lease payments. Therefore, the waiver of lease payments is a lease modification. IFRS 16.87 provides guidance on the accounting for a modification to an operating lease.

Under IFRS 16.87, prepaid lease payments relating to the original lease are considered part of the lease payments for the new lease. Therefore, no portion of the lease incentive is derecognised.

4 Changes to operating leases that are not lease modifications

Changes in lease payments that result from terms in the original lease contract or in applicable law or regulations are part of the original terms and conditions of the lease, even if the effect of those clauses was not previously considered. If there is no change in either the scope of or the consideration for a lease, then there is no lease modification and IFRS 16’s other requirements are applied. (IFRS 16.81)

Case – Deferral of lease payments not a lease modification

Landlord L leases retail space to Tenant Z and classifies the lease as an operating lease. The lease includes fixed lease payments of 10,000 per month.

Due to the COVID-19 pandemic, L and Z agree on a rent concession that allows Z to pay no rent in the period from July to September 2020 but to pay rent of 20,000 per month in the period from January to March 2021. There are no other changes to the lease.

L determines that the reduction in lease payments in July to September 2020 and the proportional increase in January to March 2021 do not result in an overall change in the consideration for the lease.

L does not account for the change as a lease modification. L continues to recognise operating lease income on a straight-line basis, which is representative of the pattern in which Z’s benefit from use of the underlying asset is diminished.

Food for thought – Is a rent deferral that increases the future lease payments a lease modification?

Not necessarily.

The Board’s document notes that if lease payments are deferred during the period of the COVID-19 pandemic and are subsequently increased ‘proportionally’, then the consideration for the lease is unchanged. In the absence of other changes to the lease, this means that there is no lease modification.

The Board’s document does not elaborate on the meaning of the term ‘proportionally’ and the amendments do not use the term. This means that lessors will need to determine an appropriate definition of the term and apply it consistently.

For example, 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 the lessor assesses whether the lease payments have been increased ‘proportionally’.

Food for thought – What are the accounting implications for the landlord if a tenant does not make rent payments when they are due?

As discussed previously, a lease modification is a change to the terms and conditions of the lease. If the tenant fails to pay amounts due under the lease contract with no agreement with the landlord, then this is not a lease modification. (IFRS 16.76, IFRS 16.77, IFRS 16.81)

Instead, the landlord will continue to account for the lease under its original terms and conditions unless and until the landlord agrees to modify the contract.

However, if the tenant fails to pay amounts due under the lease contract, or the landlord is otherwise concerned that the tenant may be unable to pay amounts falling due in future periods, then there are a range of other issues that the landlord needs to consider.

Operating leaseLandlord Lease modifications

For operating leases, these issues include but are not limited to the following.

  • Income recognition: Operating lease income reflects the rental payments to which the landlord is entitled under the enforceable terms and conditions of the lease. In addition, the landlord will need to assess whether it remains appropriate to recognise income from non-lease components – e.g. maintenance income under IFRS 15.
  • Carrying amount of the underlying asset: Landlords will need to ensure that the underlying asset is appropriately measured. For investment property measured at fair value, this will include ensuring that the fair value reflects current market participant expectations about in-place leases and residual values. For other underlying assets, this will include considering whether there is a trigger for impairment testing.
  • Lease receivables: Operating lease receivables are subject to impairment testing under IFRS 9.

Example

Landlord L leases a store to a retailer for fixed lease payments of 100 per month. L classifies the lease as an operating lease. For the last six months of 2020, due to financial difficulty, the retailer pays only 50 per month, with the intention to repay the balance in 2021. No modification agreement is signed between the landlord and the tenant.

L recognises revenue of 1,200 for 2020, collects 900 and records a receivable of 300. The lease receivable is subject to impairment testing under IFRS 9.

Finance lease

In a finance lease, although the landlord will continue to account for the lease under its original terms and conditions, the carrying amount of the net investment in the lease and interest income related thereto may be impacted. The landlord applies IFRS 9’s impairment requirements to the net investment in the lease and regularly reviews the estimated unguaranteed residual values used in computing the gross investment in the lease. The landlord applies IFRS 16 to recognise reductions in the unguaranteed residual value of the underlying asset.

Food for thought – Should a landlord continue to recognise operating lease income on a straight-line basis if the tenant’s business is impacted by COVID-19 or government restrictions?

Generally, yes. (IFRS 16.81)

In most commercial real estate leases, the benefit conveyed by the landlord to the tenant is the right to use the underlying property over the lease term. For this reason, operating lease income from real estate leases is typically recognised by the landlord on a straight-line basis from the commencement date over the lease term.

IFRS 16 states that it is possible to recognise operating lease income using another systematic basis if that is more representative of the time pattern in which the benefit of the underlying property is diminished. However, it is rare that a basis other than straight-line meets this test in a real estate lease. For example, a retailer that leases a retail store from a landlord may expect its sales at the store to vary seasonally, and may project year-on-year increases in sales.

However, the benefit that the retailer receives under the lease is the right to use the store. Therefore, if the lease payments are fixed, then the landlord would recognise operating lease income on a straight-line basis in this fact pattern.

A question arises about whether this approach remains appropriate if the COVID-19 pandemic significantly reduces sales at the store and/or the government imposes restrictions that reduce footfall at the store.

In the absence of a change in the lease agreement, the tenant’s benefit under the lease agreement remains the right to use the store. As long as the landlord continues to convey the right to use the store to the retailer, the landlord will typically continue to recognise operating lease income on a straight-line basis.

5 Modifications to finance leases

The landlord’s accounting for a modification to a finance lease depends on whether the modification in substance represents the creation of a new lease that is separate from the original lease. The landlord accounts for such a modification as a separate lease. (IFRS 16.79–80, IFRS 16.BC238–BC239)

Something else -   Cash flows from discontinued operations IFRS 5 - 2 Detailed Examples

The accounting for a modification to a finance lease that is not accounted for as a separate lease further depends on whether the lease classification would have been different had the modified terms been in effect at the inception date.

5.1 Separate lease

A landlord accounts for a lease modification as a separate lease if both of the following conditions exist:

  • the modification increases the scope of the lease by adding the right to use one or more underlying assets; and
  • the consideration for the lease increases by an amount equivalent to the stand-alone selling price for the increase in scope and any appropriate adjustments to that stand-alone selling price to reflect the circumstances of the particular contract. (IFRS 16.79)

One common type of modification to a real estate lease is that the lease is modified to include additional space. For example, a landlord that already leases space in an office building to a tenant may agree to lease additional space in the same office building. When the lease payments for the additional space reflect the stand-alone selling price for it, the landlord accounts for the space as a separate new lease.

In this case, the landlord:

  • accounts for the separate lease (i.e. the lease of the additional floor) in the same way as any new lease; and
  • makes no adjustment to the initial lease.

Case – Modification that is a separate lease

Landlord L entered into a lease contract with Tenant Z to lease one floor in an office building for 30 years. L classifies this lease as a finance lease because it transfers substantially all of the risks and rewards incidental to ownership of office space. (IFRS 16.79)

During the first 20 years, Z’s business has expanded and Z now requires additional office space.

At the beginning of Year 21, L and Z amend the contract to grant Z the right to use one floor of office space in a new extension of the building for 10 years. The new office space is the same size as the original office space and similar in all significant respects.

The lease payments for the new office space are commensurate with market rentals for office space of that size and characteristic. However, Z receives a 5% discount for the new office rentals because its existing relationship with L enabled L to forego costs that it would have incurred if the additional floor had been leased to a new tenant – e.g. marketing costs, rental agent’s commission and costs for undertaking credit checks.

The lease of the additional office space was not part of the original terms and conditions of the contract. Therefore, this is a lease modification.

L accounts for this modification as a separate lease at the effective date of the lease modification because:

  • the modification increases the scope of the lease by adding the right to use an additional underlying asset – i.e. an additional floor of office space; and
  • the lease payments for the additional floor are commensurate with market rentals for a similar office space, as adjusted for the circumstances of the contract. Even though the lease payments for the new office space are 5% below market rentals, the discount reflects L’s sharing with Z of the benefit of not having to market the property or pay a broker’s commission and not having to incur other common origination fees.

L does not modify the accounting for the original office space lease. L classifies the lease of the additional floor space as an operating lease because the lease term is not for the major part of the economic life of the underlying asset and no other features indicate that the lease transfers substantially all of the risks and rewards incidental to ownership of the underlying asset.

5.2 Not a separate lease – Finance to operating: Modifications related to COVID-19

IFRS 16.80(a) When a modification to a finance lease is not a separate lease, the lessor first assesses whether the classification of the lease would have been different if the modified terms had been in effect at the inception date.

The lessor does this at the effective date of the modification – i.e. when the modification is agreed, not on expiry of the original lease term.

If a modification to a finance lease is not a separate lease and the lease would have been classified as an operating lease if the modified terms had been in effect at the inception date, then the lessor: (IFRS 16.80(a))

  • accounts for the lease modification as the termination of the original lease and the creation of a new lease from the effective date of the modification; and
  • measures the carrying amount of the underlying asset as the net investment in the original lease immediately before the effective date of the lease modification.

Case – Modification that is not a separate lease and lease would have been classified as an operating lease

Landlord L enters into a lease contract with Tenant Z to lease one floor in an office building for 30 years. Initially, L classifies this lease as a finance lease because it transfers substantially all of the risks and rewards incidental to ownership of office space. (IFRS 16.63–66, IFRS 16.79–80(a))

During the COVID-19 pandemic, M’s business has contracted. In June 2020, four years after the commencement date, L and M amend the contract so that it now terminates on 31 December 2020.

Early termination was not part of the original terms and conditions of the lease and is therefore a lease modification. The modification does not grant M an additional right to use the underlying assets and therefore cannot be accounted for as a separate lease.

L determines that, had the modified terms been effective at the inception date, the lease term would not have been for the major part of the economic life of the asset. Furthermore, there are no other indicators that the lease would have transferred substantially all of the risks and rewards incidental to ownership of the office space. Consequently, the lease would have been classified as an operating lease.

In June 2020, L accounts for the modified lease as a new operating lease. L:

  • derecognises the finance lease receivable and recognises the underlying asset in its statement of financial position according to the nature of the underlying asset – i.e. as investment property in this case; and
  • measures the aggregate carrying amount of the underlying assets as the amount of the net investment in the lease immediately before the effective date of the lease modification.

5.3 Not a separate lease – Finance to finance: Modifications related to COVID-19

If a modification to a finance lease is not a separate lease and the lease would have been classified as a finance lease had the modification been effective at the inception date, then the lessor accounts for it under the requirements of IFRS 9. (IFRS 16.80(b))

The lessor adjusts its measurement of finance lease receivables to reflect any reduction in future contractual lease payments that arise from a rent concession arising directly from the COVID-19 pandemic.

Also read: IFRS 16 Lease modifications lessor

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Something else -   IFRS 15 Contracts with customers

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Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications Landlord Lease modifications

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