Audit Partner at RSM Poland
As I mentioned in my previous article on Asset measurement in a state of epidemic and economic slowdown, the measurement should be careful when it comes to right-of-use assets (i.e. leased assets, as they are popularly called), all the more so since an amendment to IFRS 16 has been in force for more than a month now.
What the amendment to IFRS 16 is all about for lessees?
As we have argued in a series of articles on IFRS 16, it is very important to closely analyse any contract that gives you the right to use an asset. Under an agreement, one party (lessor) conveys the right to use real estate or movable property to the other party (lessee), and to be more precise: transfers the right-of-use asset in exchange for consideration. Even if the agreement does not specify the period of time for which the right is being conveyed, the lessee is obliged to determine the most likely scenario that will be the basis for determining payments being, in turn, the basis for the initial measurement of the asset and lease liability. That means, in other words, that providing a proper time frame is necessary (but not sufficient, though) for the initial measurement to be appropriate. The situation we have had in the past months brought about some additional arrangements between the parties; in most cases, they resulted in lease payment holidays or reductions. Some limitations to the right-of-use would often be introduced, as well, e.g. upon request of the user, the office space used was reduced by 15-25%. Many accountants were asking themselves a question of how to recognise such changes in the books in line with IFRS 16 and how to present them in the quarterly, and soon in the half-year financial statements?
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However, before we move on to specific solutions put forward by the International Accounting Standards Board, let me remind you that a lease modification is any change to the contract that results in a longer/shorter contract term, an increased/decreased number of assets involved (in respect of which the user has acquired the right-of-use) or increased/decreased lease payments. Let us call them ‘major modifications’. These ‘major modifications’ to lease terms and conditions cause a dilemma: is it a new lease we are dealing with or is it enough to modify the existing lease? As you can see, the algorithm got complicated, in particular for any re-negotiations and modifications to the original terms and conditions by the parties. After all, any rent holiday or reduction should be analysed each time in the light of paragraphs 44-46 of IFRS 16.
The Board’s decisions come to the rescue
More than a month ago, paragraphs 46A, 46B and 60A, C1A and C20A and C20B were added to IFRS 16. What do they mean?
In general, paragraphs 46A and 46B provide that the lessee may elect not to assess whether rent concession in the form of a deferred payment for the lease of an asset (right-of-use asset) is a lease modification. Provided that the conditions set forth in paragraph 46B are met, the lessee may treat this change as if it was not a lease modification.
When is a change of consideration for right-of-use assets not a lease modification? Paragraph 46B states that all of the following conditions must be met:
- the change in lease payments results in a revised consideration for the lease that is substantially the same as, or less than, the consideration for the lease immediately preceding the change;
- any reduction in lease payments affects only payments originally due on or before June 2021 (for example, a rent concession/lease amendment for the lessee would meet this condition if it results in reduced lease payments on or before 30 June 2021 and increased lease payments that extend beyond 30 June 2021 at the same time);
- there is no substantive change to other terms and conditions of the lease.
What should be noted is that the amendment to IFRS 16 applies only to those lease changes that involve COVID-19 related rent concessions. For example, any changes of the lease scope (an increase or decrease of the number of assets transferred for use) or a longer or shorter lease term are most common lease modifications, in particular if these changes were not included in the original terms and conditions, and do not constitute grounds for exemption referred to in the amendment to IFRS 16. In the light of paragraphs 46A and 46B that were introduced, if on or before 30 June payments are reduced or deferred e.g. for a period of 5 months, but subsequent payments are proportionately increased by the portion earlier reduced or suspended, so that in principle the lessee will pay the same amount of consideration in total, we may say that the total amount agreed by both parties remains the same, hence the consideration to be paid has not changed and this change is not considered to be a lease modification.
Summing up, I should add here that whenever the lease scope or lease consideration has changed, the entity should consider whether that change was not part of the original terms and conditions of the lease. The entity applies paragraph 2 of IFRS 16 and considers the lease terms and conditions as well as any relevant facts and circumstances. Relevant facts and circumstances may include contracts, statutory provisions or other laws and regulations that apply to concluded contracts.
For example, commercial lease contracts may include clauses about changes of payments arising out of or caused by certain events or circumstances. Measures introduced by the government (for example, the requirement to close retail stores for a certain period of time due to COVID-19) may be relevant for the interpretation of legal clauses, such as force majeure, included in the original contract or applicable laws and regulations. Any changes of payments resulting from clauses in the original contract or the applicable regulations constitute original lease terms and conditions and are not a lease modification for IFRS 16 purposes.
Last but not least, I have to mention that the changes introduced by the Board have been approved by EFRAG and are expected to be approved by the EU at the turn of the 3rd and 4th quarter. The amendment to IFRS 16 can be applied to financial statements for a period starting on or after 1 June 2020 and retrospectively, including unsigned (not authorized) financial statements as at 28 May 2020. This is provided for in paragraph C1A and C20A. Applying the practical expedient means the lessee must make relevant disclosures, as set forth in paragraph 60A, while under paragraph C20B lessees are exempt from disclosing information (required under IAS 8) about the disclosures of any adjustments for each financial statement line item affected by the amendment to IFRS 16.
Should you have any questions, we encourage you to contact us directly, as always.
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