Many Australian entities will be applying the new leases standard, AASB 16, for the first time in their 30 June 2020 financial statements. It is unfortunate timing, to say the least, considering all that has transpired over the past few months. Lessors have been offering rent concessions such as rent reductions, rent holidays and rent deferrals to lessees in response to current economic conditions, further complicating lease accounting under a new standard, during a time when many entities are facing significant challenges.
Luckily for lessees, the International Accounting Standards Board (IASB) has offered some practical relief to simplify the accounting for changes to lease arrangements that are directly linked to the pandemic. This relief will be particularly beneficial to those lessees that have a large number of leases with a variety of lease terms, and for which the concessions granted are different.
Lease modification accounting under AASB 16
Without the relief offered by the IASB, lessees would be required to assess whether any rent concessions they receive meet the definition of a ‘lease modification’ under the new leases standard. A lease modification arises when there is a change in the scope of, or consideration for, a lease that was not part of the original terms and conditions of the lease.
Generally speaking, rent reductions and rent holidays would be lease modifications under the new leases standard. This means, under the usual requirements of AASB 16, the original lease would have to be remeasured by:
- Appropriately revising the discount rate;
- Calculating the net present value of the revised future lease payments using the updated discount rate; and
- Making a corresponding adjustment (decrease) to the right-of-use (ROU) asset for the decrease in the lease liability. Where the adjustment is greater than the carrying amount of the ROU asset, the excess would be recognised as a gain in profit or loss.
The above remeasurement would entail a substantial amount of work for lessees. Furthermore, the assessment of whether changes are in fact lease modifications could be complicated by force majeure clauses. Judgement may be necessary to determine whether such clauses (whether imposed by law or an agreement) are triggered by COVID-19.
The relief offered
The amendment to AASB 16 essentially eliminates the need, if a lessee so chooses, to determine whether COVID-19-related rent concessions are lease modifications or not. Instead, the lessee accounts for the rent concession as if the change was not a lease modification in accordance with the requirements of AASB 16 paragraph 38. This means the change in lease payments is treated as a variable lease payment in profit or loss in the period in which the event or condition that triggers those payments occurs.
To be eligible to apply the optional practical expedient, all of the following conditions need to be met:
- The revised consideration for the lease is substantially the same as, or less than, the original consideration;
- The reduction in lease payments relates to payments originally due on or before 30 June 2021; and
- There are no other substantive changes to the terms of the lease.
With respect to the second dot point above, this implies that the practical expedient applies to those payments that are reduced or deferred on or before 30 June 2021 even if subsequent rental increases extend beyond 30 June 2021.
Lessees that elect to apply the practical expedient must apply it consistently to all leases with similar characteristics and in similar circumstances.
No similar relief is provided for lessors. Lessors are required to continue to assess if the rent concessions are lease modifications and account for them accordingly.
The following disclosures are required when the practical expedient is used:
- The fact that the practical expedient has been applied to all eligible rent concessions, or if only some of them, the nature of the contracts to which it has been applied; and
- The amount recognised in profit or loss for the change in lease payments arising from the rent concessions, as a result of applying the practical expedient.
Effective date and transition
The amendment is applicable for reporting periods beginning on or after 1 June 2020 with earlier application permitted, including for financial statements not yet authorised for issue at the date the amendment was issued. The Australian-equivalent amendment, AASB 2020-4 Amendments to Australian Accounting Standards – Covid-19-Related Rent Concessions, was issued on 15 June 2020.
Retrospective application is required but only by adjusting the opening balance of retained earnings in the financial statements in which the relief is first applied, rather than by restating prior period numbers.