Accounting for COVID-19 related rent concessions

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 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.

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.

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.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act upon such information without appropriate professional advice after a thorough examination of the particular situation.