Focus on IFRS 16 Leases
summarises the process surrounding changes in lease contracts that identify as lease modification.
A lessee that chooses not to apply the practical expedient (IFRS 16 option for rent concessions arising directly from the COVID-19 pandemic that are not going to be accounted for as lease modifications), or agrees changes to its lease contracts that do not qualify for the practical expedient, assesses whether there is a lease modification.
A change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions meets the standard’s definition of a lease modification.
A lessee accounts for a lease modification as a separate lease if both of the following conditions exist:
For a modification that is not a separate lease, at the effective date of the modification the lessee accounts for it by remeasuring the lease liability using a discount rate determined at that date and:
summarises the accounting for lessor modifications that depends on – and may change – the lease classification.
Unlike IAS 17 Leases, the new standard provides detailed guidance on the lessor accounting for lease modifications, with separate guidance for modifications to finance leases and operating leases.
However, additional complexities arise for modifications of a finance lease receivable not accounted for as a separate lease for which, under paragraph 80(b) of IFRS 16, the lessor applies the requirements of IFRS 9 Financial Instruments. A number of issues arise due to differences in the basic concepts between IFRS 16 and IFRS 9.
The following diagram summarises the accounting for lease modifications by a lessor.
|Separate lease||Not a separate lease – Finance to operating||Not a separate lease – Finance to finance||Lessor modifications to operating expenses|
* A lessee reassessment of whether it is reasonably certain to exercise an option to extend, or not to exercise a termination option, included in the original lease contract is not a lease modification
The date on which to account for a lease modification is a key consideration – and may be earlier than you think.
Lease modifications are accounted for at the effective date of the lease modification. This is the date on which both parties agree to the lease modification. For modifications that are not accounted for as separate leases, the lease liability and right-of-use asset are remeasured at this date.
Complex application issues arise if the modification is agreed on one date but an additional right of use starts on a later date. This section illustrates some issues. IFRS 16 Effective date of a modification
The following diagram summarises the accounting for common scenarios in which a modification is agreed on one date but the change in the right of use or consideration happens at a different date. IFRS 16 Effective date of a modification
When a modification is accounted for as a separate new lease, it is accounted for in the same way as any other new lease.
IFRS 16 amendments Corona Rent concessions provide relief to lessees in accounting for rent concessions.
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:
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.
IFRS 16.26 sets out the discount rate requirement as follows:
“At the commencement date, a lessee shall measure the lease liability at the present value of the lease payments that are not paid at that date. The lease payments shall be discounted using the interest rate implicit in the lease, if that rate can be readily determined. If that rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate.”
Given a significant number of organisations are unlikely to have the necessary historical data to determine the interest rate implicit in the lease (“IRIIL”) for transition, it seems logical that the use of the incremental borrowing rate (“IBR”) will be relatively common at the date of adoption.
Additionally, any company choosing to use one of the modified retrospective approaches is required to use the IBR. For leases signed after transition, companies may be more readily able to determine IRIIL, however it is likely that companies will enter into leases which require the continued use of the IBR.
“The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right of use asset in a similar economic environment.”
Additional detail on determining the incremental borrowing rate can be found in the guidance outlining the transition related practical expedient for using a single discount rate for a portfolio of leases:
“a lessee may apply a single discount rate to a portfolio of leases with reasonably similar characteristics (such as leases with a similar remaining lease term for a similar class of underlying asset in a similar economic environment).”
Combining these two aspects together results in the six factors (in green) requiring consideration in determining an IBR, either for an individual lease or a portfolio of leases.
Impairment of right-of-use assets explains the lease assets now on the balance sheet and as a result also susceptible of impairment risks to be accounted for. Impairment of right-of-use assets
Right-of-use asset is an asset that represents a lessee’s right to use an underlying asset for the lease term. Impairment of right-of-use assets
A contract conveys the right to control the use of an identified asset if the customer has both the right to obtain substantially all of the economic benefits from use of the identified asset and the right to direct the use of the identified asset throughout the period of use/lease. Impairment of right-of-use assets
The right-of-use asset is depreciated over the lease term
New Lease Standard Comparing IFRS and US GAAP – The FASB and IASB issued their respective standards in the first quarter of 2016. The issuance of the standards are the culmination of multiple years of deliberating a leasing model with the primary objective of bringing almost all leases onto the balance sheet for lessees. The leases standard was initially intended to be a converged standard; however, the Boards ultimately diverged and as a result there are some differences between the two new standards.
The FASB discussed numerous lease-related questions since issuing ASC 842, and issued five Accounting Standards Updates during 2018 and 2019 relating to: the accounting for easements, certain technical corrections, targeted improvements to the transition provisions, a lessor’s … Read more