Photo by Drew Beamer on Unsplash
Welcome back to my third post on COVID-19 impacts on financial statements. Please click on below two links If you have missed my first two posts.
COVID-19 & Financial Reporting
IAS 36 Impairment & COVID-19
In today's post, we shall study IFRS 16 Leases and how it has become so relevant during COVID-19 that IASB recently issued an exposure draft for a proposed waiver to lessees.
Post shall be divided into below parts.
a) A short throwback/intro of IFRS 16. Only the lessee part of lease.
b) Relevance to recent crisis and IASB exposure draft.
a) IFRS-16 Leases
IASB stance of having all leases on balance sheet comes to an end with the IFRS 16. It all started what IASB says that entities are manipulating the earlier lease guidance by using off balance sheet financing. We also heard of joint session between IASB and FASB which at the end couldn't agree on single agreed standard. FASB issued its standard with the same "On Balance Sheet approach" but with a little variation.
Para-9 of the standard defines the lease as;
At inception of a contract, an entity shall assess whether the contract is, or contains, a lease. A contract is, or contains, a lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
An asset is typically identified by being explicitly
specified in a contract, but an asset can also be identified by being
implicitly specified at the time it is made available for use by the customer.
However, where a supplier has a substantive right of
substitution throughout the period of use, a customer does not have a right to
use an identified asset. A supplier’s right of substitution is only considered
substantive if the supplier has both the practical ability to substitute
alternative assets throughout the period of use and they would economically
benefit from substitution.
Appendix-B30 also provides us a decision tree to help understand that whether a contract contains a lease or not.
Since we are focusing just on the lessee part in this post, so let me rewind you the accounting treatment. Para 22 to 46 of the standard explain this accounting treatment.
Initial Measurement
At the commencement date, a lessee shall measure the right-of-use asset at cost, Para 23.
The cost of right-of-use shall comprise:
a) The amount of initial measurement of lease liability
b) The lease payments made at or before the commencement date. less any incentives received
c) Any indirect costs incurred by the lessee
d) An estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it is located or restoring the asset to the condition required by the terms and conditions of the lease, unless those costs are not incurred to produce inventories.
In case of costs incurred to produce inventories, a separate liability shall be booked as per IAS 37 provision, contingent liabilities and contingent assets.
Opposite to Right-Of-Use Asset, lessee shall also record the lease liability. para 26 to 28 explains the measurement at commencement date:
At the commencement date, a lessee shall measure the lease
liability at the present value of the lease payments that are not paid at that
date. The lease payments shall be discounted using the interest rate implicit
in the lease, if that rate can be readily determined. If that rate cannot be
readily determined, the lessee shall use the lessee’s incremental borrowing
rate.
Following shall be included in the lease liability:
a) Fixed payment to be paid during the term of the lease, less any incentives received
b) Variable lease payment that depend on an index or a rate
c) Any residual value guarantees
d) The exercise price of a purchase option if the lessee is reasonably certain to exercise that option.
e) Payments for penalties for terminating the lease, if lease term reflects the lessee exercising an option to terminate the lease.
Subsequent Measurement
Subsequently Right-Of-Use Assets' measurement is narrated within the para no. 29 to 35.
After the commencement date, a lease shall measure the right-of-use asset applying a cost model, except in below cases:
a) Lessee applies IAS 40 to the asset class which is leased
b) It related to class of property, plant and equipment to which the lessee applies the revaluation model in IAS-16
To apply a cost model, a lessee shall measure the right-of-use asset at cost:
a) Less any accumulated depreciation and accumulated losses; and
b) adjusted for any re measurement of lease liability
A lessee shall apply the depreciation model as per IAS 16 and impairment as per IAS 36.
Subsequent measurement of lease liability start from para 36 till 46. A lessee shall measure the subsequent lease liability by:
a) increasing the carrying amount to reflect interest on the liability
b) reducing the carrying amount to reflect the lease payments made
c) remeasuring the carrying amount to reflect reassessment or lease modification.
Variable payment which are not included at the commencement time in lease liability shall be recorded in profit and loss in the period in which a condition or event that triggers those payment occurs.
Lease liability shall also be reassessed to reflect changes in :
a) Lease term (using a revised discount rate)
b) Assessment of an option to purchase the underlying asset (using a revised discount rate)
c) The amount to be payable under residual value guarantee (using the same old discount rate)
d) Lease payments resulting from a change in an index or rate used to determine those payments (using the same old discount rate)
Lease modification shall trigger the reassessment of lease liability except in cases where lease modification is considered a separate lease. (para 44 to 46).
Below diagram shall help to explain the above narrated measurement model described by standard.
b) Relevance to recent crisis and IASB exposure draft.
COVID-19 hit to economy is now roaring in the lease sector where lease amounts are being waived off or being asked by lessees for concessions or rental holidays. According to recent survey of Indian banking sector, banks are looking to reduce their lease amounts by 10% to 20%. Same report says:
We will be looking to optimise rental costs, though it still early days. We haven’t spoken to landlords,” an RBL Bank spokesperson said. “Our administration team is looking at how best to capitalise the work from home culture to reduce office space requirements.Read more at:
https://economictimes.indiatimes.com/industry/banking/finance/banking/in-times-of-covid-19-banks-look-to-bring-down-rent/articleshow/75264212.cms?utm_source=contentofinterest&utm_medium=text&utm_campaign=cppst
IFRS-16 explains how a change in lease shall be accounted. Para 45 and 46 of standard requires that if a modification isn't considered to be a separate lease then lessee shall remeasure the lease liability for such lease with the new revised discount rate.
For a lease modification that is not accounted for as a separate lease, the lessee shall account for the remeasurement of the lease liability by:
(a) decreasing the carrying amount of the right-of-use asset to reflect the partial or full termination of the lease for lease modifications that decrease the scope of the lease. The lessee shall recognise in profit or loss any gain or loss relating to the partial or full termination of the lease.
(b) making a corresponding adjustment to the right-of-use asset for all other lease modifications. (para 45)
The lessee shall perform such re measurement for all the leases in hand which are affected. IASB recently discuss this issue in a board meeting in April 2020 and issued an exposure draft for the proposed practical expedient amendment.
You may have a copy of this exposure draft on below link:
The objective of the exposure draft is to make accounting easier for the lessees in a scenario of temporary decreasing lease rentals, concession or rent holidays. This proposed amendment will give lessees right to not consider such reduction a lease modification. The amendment would apply to COVID-19 related rent concession which shall be due in year 2020. Exposure draft is issued with a 14 days commenting period and IASB announces to issue the final amendment during May 2020.
Exposure draft mention:
As a practical expedient, a lessee may elect not to assess whether a covid-19- related rent concession (see paragraph 46B) is a lease modification. A lessee that makes this election shall account for any change in lease payments resulting from the covid-19-related rent concession the same way it would account for the change applying this Standard if the change were not a lease modification.
As far as lease liabilities are concerned, surely this exposure draft is sigh of relief to lessees who otherwise have to perform cumbersome work of reassessing the lease liabilities of each lease with the new revised discount rates.
With respect to Right-Of-Use Assets falling on the asset side, standard narrates to follow cost-model with the exception of investment property and PPE with revaluation model. IAS also emphasis to use the impairment as per IAS 36 on the Right-Of-Use Assets. So although lessees can take benefit from the proposed amendment by IASB, they still have to consider the cost model of asset and assess the impairment as mentioned in standard.
------------------------------------------
Comments
Post a Comment