(Second of two parts)
In the first part of this article, we discussed the regulatory relief that the government provided to ease the impact of the pandemic on businesses. These include the 60-day grace period for all existing, current, and outstanding loans with principal and/or interest. We also discussed concessions for banks and non-bank institutions, and the impact of these relief efforts on financial reporting.
In this second part, we will cover how to apply the COVID-19-related Rent Concessions Amendment to IFRS 16 on accounting for lease modifications. For lease arrangements, IFRS 16 Leases provides guidance on accounting for changes in lease payments for both lessees and lessors. However, IFRS 16 may be difficult to apply in accounting for changes to lease payments.
In particular, assessing whether rent concessions are lease modifications and applying the relevant accounting guidance could prove difficult if there are many lease contracts affected by the pandemic. Multiple changes to each or some of the lease arrangements can also compound the issue.
EFFECT OF COVID-19-RELATED RENT CONCESSIONS
In May, the International Accounting Standards Board (IASB) issued the COVID-19-related Rent Concessions Amendment to IFRS 16. It provides optional relief to lessees from applying IFRS 16’s guidance in accounting for lease modifications arising from rent concessions given as a direct consequence of the pandemic.
The Financial Reporting Standards Council (FRSC) adopted the international amendment and issued the COVID-19-related Rent Concessions Amendment to PFRS 16. This aims to provide lessees that have been granted COVID-19-related rent concessions by lessors with practical relief while still providing useful information about leases to users of the financial statements.
Prior to the amendment, when a rent concession is granted by a lessor, a lessee assessed whether such a rent concession qualifies as a lease modification. A lease modification is defined in PFRS 16 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. Such guidance under PFRS 16 in accounting for pandemic-related lease concessions can be difficult, especially if there are many contracts to deal with and the rent concessions qualify as lease modifications. Our previous article Consensus in lease concessions due to COVID-19 by Jerome B. Ching, published on June 8 and 15, covers further details regarding assessing and accounting for lease modifications.
ACCOUNTING FOR LEASE MODIFICATION PRIOR TO THE AMENDMENT
A lease modification that increases the scope of the lease and increases the consideration by an amount commensurate with the stand-alone price is accounted for as a separate lease.
For a lease modification not accounted for as a separate lease, a lessee applies modification accounting at the effective date of the lease modification (i.e., the date when both parties agreed to the lease modification). In such a case, a lessee allocates the consideration in the modified contract to the lease and non-lease components (where applicable), determines the lease term of the modified lease, and remeasures the lease liability by discounting the revised lease payments using a revised discount rate determined on that date.
If the modification decreases the scope of the lease (e.g., reduces total leased space or the lease term), the lessee remeasures the lease liability and reduces the right-of-use asset to reflect the partial or full termination of the lease. Any difference between those two adjustments is recognized in profit or loss at the effective date of the modification.
For all other modifications, the lessee recognizes the amount of the remeasurement of the lease liability as an adjustment to the right-of-use asset, without affecting profit or loss.
Questions have been asked as to whether the lease concessions mandated by Bayanihan I and II constitute a lease modification.
Some stakeholders believe that in these cases, changes to the lease were not part of the original terms and conditions and thus require modification accounting.
However, other stakeholders take the view that when the lessee and lessor agreed to a lease contract, subject to the law of a jurisdiction, the parties also agreed to be bound by any future changes in applicable laws. Any changes therefore made to comply with a change in law are contemplated in the contract and should not be considered as a lease modification.
Given that PFRS 16 does not specifically address this circumstance, there are likely differences in practice. Both approaches are acceptable. It is important to note, however, that irrespective of the view taken, a lease concession will not qualify as a lease modification only to the extent of what the law provides.
For example, if the law requires a waiver only during the period of the pandemic, any concession provided beyond such period is a form of lease modification. Similarly, if the law requires a full waiver during a specified period, but if the lessor granted only 50% waiver which was also accepted by the lessee, the other 50% of the lease payments that would have been waived but were not constitute a lease modification.
Moreover, some agreements include provisions that allow changes if unexpected events occur, such as a force majeure clause. However, these clauses do not automatically make the changes part of the original terms and conditions of contracts, as these are usually written in general terms and do not provide specific contractual rights and obligations that arise from the occurrence of a force majeure event. Therefore, the lessor and lessee may need to revisit the lease contract and agree on the coverage of a force majeure clause, including the involvement of legal experts.
PRACTICAL EXPEDIENT TO ACCOUNTING FOR LEASE PAYMENT CHANGES
With the amendment, a lessee may elect not to assess if a COVID-19-related lease concession from a lessor is a lease modification and simply account for such as it normally would under PFRS 16, assuming the change was not a lease modification. The amendment does not provide any practical expedient to lessors.
It should be noted that the practical expedient under the amendment applies only to rent concessions occurring as a direct consequence of the pandemic, and only if all the necessary conditions are met.
First, the change in lease payments must result in a revised consideration for the lease that is substantially the same as, or less than, the consideration for the lease immediately preceding the change. Second, any reduction in lease payments must also affect only payments originally due on or before 30 June 2021. For example, a rent concession meets this condition if it results in reduced lease payments before June 30, 2021, but reductions are recovered through equivalent increase in lease payments after June 30, 2021. This satisfies the condition because the intent is only to defer the payments without increasing the total lease consideration. Third, there must be no substantive change to other terms and conditions of the lease.
ACCOUNTING FOR RENT CONCESSIONS BASED ON THE AMENDMENT
The amendment does not provide explicit guidance on how a lessee accounts for a rent concession when applying the practical expedient.
There are a number of potential approaches in accounting for a rent concession that is not accounted for as a lease modification. One approach is to account for a concession in the form of forgiveness or deferral of lease payments as a negative variable lease payment. In this case, the lessee remeasures the lease liability based on revised remaining lease payments without updating the discount rate (if the contract contains multiple components, reallocating the remaining payments proportionately between the lease and non-lease component using the same allocation from the original contract). This approach is similar to that used by the lessor to recognize variable lease income, is also easier to apply and immediately effects the concession to profit or loss.
Another approach is to account for the abovementioned concession as a resolution of a contingency that fixes previously variable lease payments. The lessee remeasures the lease liability similar to the first approach, with a corresponding adjustment to the right-of-use asset. This approach is also easy to apply, but will not immediately affect profit or loss.
The third approach is to account for the lease liability and right-of-use asset using the rights and obligations of the existing lease and recognizing a separate lease payable (that generally does not accrue interest) in the period that the allocated lease cash payment is due. In this case, the lessee continues to recognize the unpaid lease payment (i.e., as a lease payable) without accruing interest until it makes the lease payment at the revised payment date. In this approach, the lessee need not revisit the accretion of its lease liability based on the revised timing of payments. In many cases, this allows a lessee to use its existing systems to account for the lease liability using the existing payment schedule and discount rate.
ECONOMIC RECOVERY AND COMPLIANCE
With the pandemic’s continuing impact on the economy, government support will play a large part in preserving business confidence as we move towards a post-pandemic world. On the part of companies, a clear understanding of how COVID-related reliefs and amendments to accounting standards are crucial to ensuring not only compliance, but also a better state of preparedness as we all embark on the road to economic recovery.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the authors and do not necessarily represent the views of SGV & Co.
Rosalie T. Lapuz is a Tax Senior Manager and Leomar G. Velez is an Assurance Senior Manager from SGV & Co.