From the IFRS Institute – August 28, 2020
COVID-19 has driven many lessees to seek rent concessions from lessors, including deferral or waivers of rent. In response, IFRS 161 was amended in May 2020 to provide relief on the accounting for COVID-19 related rent concessions for lessees. These amendments introduce an optional practical expedient that allows lessees to not assess whether eligible COVID-19 related rent concessions are lease modifications, and to account for them as if they were not lease modifications. The FASB staff has provided similar practical relief to lessees and lessors under US GAAP; however, dual preparers may encounter application differences between the GAAPs.
Accounting for lease modifications under IFRS 16 can be complex and time consuming
IFRS 16 defines a lease modification 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.” It distinguishes between lease modifications that, in substance, create a new lease that is separate from the original lease and those that do not.
For lessees, modifications that do not create a separate lease require remeasurement of the lease liability and corresponding right-of-use asset at the date of the modification – using the modified lease term, revised lease payments and an updated discount rate. Modification accounting can be operationally burdensome, especially for companies with large lease portfolios that may, in the COVID-19 context, have a large volume of concessions.
Under IFRS 16, rent concessions often meet the definition of a lease modification because there is a rent reduction or other change in scope (e.g. a lease extension that accompanies a rent deferral). These modifications will typically not qualify as separate leases because they are changes to an existing right of use – e.g. a rent reduction for a building currently being leased.
The rent concession amendments to IFRS 16 in a nutshell
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;
- 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.
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 explicitly stated in the lease amendments or related correspondence;
- the timing of the negotiation and agreement of the rent concession;
- the relevant laws and regulations in the specific jurisdiction; and
- the extent and nature of, and reasons for, government intervention.
While a government lockdown 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 lockdown periods. Therefore, lessees should consider whether rent concessions agreed to before and/or after an official lockdown are also a direct result of COVID-19.
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.
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.
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.
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.
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.
Applying the practical expedient
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.
When lease payments are only deferred, it may be acceptable to either:
- 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
- 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.
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.
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.
For additional guidance on the application of the IFRS 16 amendments, see KPMG publication, Leases – Rent concessions.
- IFRS 16, Leases
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