Landlord Lease term – IFRS 16 Best complete read

Landlord Lease term

New guidance on lease term could impact the period over which operating lease incentives are recognised in profit or loss, particularly for renewable and cancellable leases.

1 Overview of landlord lease term

Determining the lease term is a critical estimate that is significant for the lessor. The lease term may affect the lease classification. For operating leases, it impacts the period over which lease incentives are recognised.

The lease term is the non-cancellable period of the lease, together with:

  • optional renewable periods if the lessee is reasonably certain to extend; and
  • periods after an optional termination date if the lessee is reasonably certain not to terminate early. (IFRS 16.18)

To determine the lease term, a lessor first determines the length of the non-cancellable period of a lease and the period for which the contract is enforceable. It can then determine – between those two limits – the length of the lease term.

The lessor determines the lease term at the commencement date.

The lease term starts when the lessor makes the underlying asset available for use by the lessee. It includes any rent-free periods. (IFRS 16 Definition, IFRS 16.B36)

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Lessee accounting under IFRS 16

Lessee accounting under IFRS 16

The key objective of IFRS 16 is to ensure that lessees recognise assets and liabilities for their major leases.

1. Lessee accounting model

A lessee applies a single lease accounting model under which it recognises all leases on-balance sheet, unless it elects to apply the recognition exemptions (see recognition exemptions for lessees in the link). A lessee recognises a right-of-use asset representing its right to use the underlying asset and a lease liability representing its obligation to make payments. [IFRS 16.22]

[IFRS 16.47, IFRS 16.49]

IFRS 16 Balance sheet Profit or loss

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IFRS 16 Lessor accounting

IFRS 16 Lessor accounting

Lessors continue to classify leases as finance or operating leases.

1. Lessor accounting model

The lessor follows a dual accounting approach for lease accounting. The accounting is based on whether significant risks and rewards incidental to ownership of an underlying asset are transferred to the lessee, in which case the lease is classified as a finance lease. This is similar to the previous lease accounting requirements that applied to lessors. The lessor accounting models are also essentially unchanged from IAS 17 Leases. [IFRS 16.B53, IFRS 16.BC289]

Are the lessee and lessor accounting models consistent?

No. A key consequence of the decision to retain the IAS 17 dual accounting model for lessors is a lack of consistency with the new lessee accounting model. This can be seen in the case Lease classification below:

There are also more detailed differences. For example, lessees and lessors use the same guidance for determining the lease term and assessing whether renewal and purchase options are reasonably certain to be exercised, and termination options not reasonably certain to be exercised. However, unlike lessees, lessors do not reassess their initial assessments of lease term and whether renewal and purchase options are reasonably certain to be exercised, and termination options not reasonably certain to be exercised (see changes in the lease term in the link).

Other differences are more subtle. For example, although the definition of lease payments is similar for lessors and lessees (see lease payments in the link), the difference is the amount of residual value guarantee included in the lease payments.

  • The lessor includes the full amount (regardless of the likelihood that payment will be due) of any residual value guarantees provided to the lessor by the lessee, a party related to the lessee or a third party unrelated to the lessor that is financially capable of discharging the obligations under the guarantee.
  • The lessee includes only any amounts expected to be payable to the lessor under a residual value guarantee.

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Best guide IFRS 16 Lessee modifications

Best guide IFRS 16 Lessee modifications

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.

Overview

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:

  • 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 price for the increase in scope and any appropriate adjustments to that stand-alone price to reflect the circumstances of the particular contract.

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:

  • for modifications that decrease the scope of the lease: decreasing the carrying amount of the right-of-use asset to reflect the partial or full termination of the lease, and recognising a gain or loss that reflects the proportionate decrease in scope; and
  • for all other modifications: making a corresponding adjustment to the right-of- use asset.

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Best guide IFRS 16 Lessor modifications

Best guide IFRS 16 Lessor modifications

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.

Best guide IFRS 16 Lessor modifications

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

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IFRS 16 Effective date of a modification

IFRS 16 Effective date of a 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

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.

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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.

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Leases explained along defined terms

Lease - a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.

New Lease Standard Comparing IFRS and US GAAP

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

Lease modifications extending the lease term

Lease modifications extending the lease term

Seemingly innocuous changes to an agreement

could be a lease modification.

They could affect your right-of-use asset and lease liability

at unexpected times with major consequences for balance sheet ratios.

Are you prepared for them?

IFRS 16 contains detailed guidance on how to account for lease modifications. A lease modification is defined as a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease. A lease modification includes adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term. Lease modifications extending the lease term

IFRS 16’s lease modification … Read more