IASB issues guidance on the application of IFRS 16, Leases, during the COVID-19 outbreak
The International Accounting Standards Board (IASB) has issued educational material to support the consistent and robust application of the requirements of International Financial Reporting Standard (IFRS) 16, Leases, during the COVID-19 outbreak.
Application of IFRS 16, Leases, during COVID-19
The IASB stresses that the educational material is intended to highlight the requirements of IFRS 16 and does not add, change or remove any of the existing requirements in the standard.
The COVID-19 crisis has resulted in concessions being granted to many commercial leases. The accounting required for any such changes to the terms and conditions of a lease will require the application of judgement and will depend upon a variety of factors, including whether such options were available in the original lease terms and conditions. These changes may arise from a direct amendment to the lease itself or indirectly as a result of government intervention in response to COVID-19.
When determining the accounting treatment for changes in lease payments, the guidance advises that an entity should consider together the contractual terms and conditions of the lease and any applicable law or regulation. This means that the accounting treatment under IFRS 16 will be the same regardless of whether the change in lease payments arises from a change to the contractual terms and conditions or as a result of any legislative or regulatory changes.
Determining whether there has been a lease modification
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 lease contract. In assessing whether there has been a change in the scope of the lease, an entity considers whether there has been a change in the right of use conveyed to the lessee by the contract. Adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term, are examples of a change in scope. However, a ‘rent holiday’ or rent reduction by itself is not a change in the scope of a lease. In determining whether there has been a change to the consideration for a lease, the overall effect of any change in the lease payments needs to be assessed, e.g. if a lessee is given a three-month rent-free period, lease payments for future periods may be increased proportionally to compensate, meaning that the consideration for the lease is unchanged.
Where there is not a change in either the scope of the lease or the consideration for the lease, then there is no lease modification.
If there has been a change in either of these, an entity then considers whether that change was part of the original terms and conditions of the lease. Paragraph 2 of IFRS 16 is to be applied and consideration given to both the terms and conditions of the contract, and all relevant facts and circumstances that may include contract, statutory or other law or regulation applicable to lease contracts. Lease contracts or applicable law or regulation may contain clauses that result in changes to payments, if particular events occur or circumstances arise. Government intervention, e.g. temporarily requiring the closure of certain types of retail store because of COVID-19, might be relevant to the legal interpretation of clauses, such as force majeure, that were in the original contract or in applicable law or regulation.
Changes in lease payments that result from clauses in the original contract or in applicable law or regulation are part of the original terms and conditions of the lease, even if the effect of those clauses (arising from an event such as the COVID-19 pandemic) was not previously contemplated. In such a case there is no lease modification for the purposes of IFRS 16.
IFRS 16 details how to account for certain changes in lease payments, e.g. those arising from changes in an index or rate used to determine lease payments. In other situations involving a change in lease payments, the required accounting depends on whether the change meets the definition of a lease modification.
The guidance addresses the process to be followed when assessing whether payment changes represent a lease modification. If this assessment indicates that the changes to lease payments result from a lease modification, lessees should apply paragraphs 44–46 of IFRS 16 and lessors should apply paragraphs 79–80, or paragraph 87, of IFRS 16.
If a change in lease payments does not result from a lease modification, the payment change should generally be accounted for as a variable lease payment as per paragraph 38 of IFRS 16. In this case, a lessee generally recognises the effect of the rent concession in profit or loss. For an operating lease, a lessor recognises the effect of the rent concession by recognising lower income from leases
Entities should also consider whether the rent concessions indicate an impairment of the related asset as a result of a loss of earnings. In these cases, the requirements of IAS 36, Impairment of assets, should be followed.
Adequate disclosure should also be made regarding the changes to lease payments as a result of COVID-19 and their effect on an entity’s financial performance and position as required by IAS 1, Presentation of Financial Statements.
The IASB will be discussing possible amendment to IFRS 16 due to COVID-19 during their meeting on 17 April 2020. Further updates will follow.
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