COVID-19: IASB posts IFRS 16 Leases guidance
21 April 2020: the International Accounting Standards Board has issued guidance on the application of IFRS 16 Leases for COVID-19-related rent concessions. There are no changes to IFRS 16, but the guidance explains how it should be applied, reports Julia Penny.
The guidance on the application of IFRS 16 Leases states that the first step in dealing with material rent holidays or concessions is to determine whether they were part of the original lease contract. Although amendments might appear to be due to COVID-19 concessions they might actually arise from changes in indices, base rates or performance measures which were embedded in the contract from the outset.
Make sure you check the detail of the contract, including consideration of all relevant facts and circumstances, such as force majeure clauses being triggered or changes in legal requirements altering the effect of the contract.
If changes in payment arise from the original lease terms, follow the requirements in paragraph 38 of IFRS 16. This will mean, in outline that:
- If variable lease payments are based on an index or rate and this changes, the lessee remeasures the lease liability and the right-of-use asset, based on the new payments required at the existing discount rate.
- If the variable lease payments are not based on an index or rate (for example they vary with sales or market prices) the changes in payments are recognised in the period in which they occur (see IE6 IFRS 16 and paragraphs 27 and 28).
If an analysis of the contract shows that the variation in payments are not as a result of the original contract, the next step is to establish whether they meet the definition of a lease modification. This requires either a change in scope or a change in overall consideration compared to the original lease terms.
COVID-19 impacts are likely to reduce the costs or the scope of the lease. This means that paragraphs 44-46 of the standard apply which, in summary, require lessees to:
- Remeasure the lease liability by discounting the revised lease payments using a revised discount rate (either the implicit rate or the incremental borrowing rate at the date of the modification).
- Decrease the carrying amount of the right-of-use asset to reflect the partial or full termination of the lease due to the modification, recognising any gain or loss in profit or loss. (IE 18 of IFRS 16 sets out an example).
In some cases, changes in lease payments result in an extinguishment of part of the lessee’s liability. Paragraph 3.3.1 of IFRS 9 should be referenced in determining whether derecognition is appropriate.
Lessees should also reconsider the lease term, even where no modification has occurred. Lease terms are often judgemental as they involve decisions about whether break clauses or extension options will be exercised. The effect of the COVID-19 situation may change previous judgements and so require remeasurements of lease liabilities and right-of-use assets.
If a change in lease payments is not related to a lease modification, then it will generally meet the definition of a variable lease payment and be recognised in profit or loss for a lessee, or a lessor of an operating lease.
Lessees and lessors should also consider whether their right-of-use, underlying or financial assets are impaired. The impact of COVID-19 will usually indicate a potential impairment so the requirements of IAS 36 Impairment of Assets should therefore be followed.
Finally, don’t forget to consider disclosures. Both lessees and lessors should ensure disclosures are sufficient to allow users to understand the impact of COVID-19 related changes in lease payments/receipts on the entity’s financial position and performance.
Julia Penny FCA is principal of JS Penny Consulting. All views expressed in this article are those of the author in a personal capacity.
For the latest news and guidance on the ongoing impact of COVID-19 for businesses and accountants, visit ICAEW’s dedicated coronavirus hub.