On 28th May, 2020,
the International Accounting Standards Board (the IASB) finalised an amendment
to IFRS 16 Leases titled ‘Covid-19-Related Rent Concessions –
Amendment to IFRS 16’. The Institute of Chartered Accountants of India
(ICAI) has already issued an Exposure Draft mirroring the IFRS 16 amendment.
This will become a standard in India when it is notified by the Ministry of
Corporate Affairs (MCA).
The modified standard
provides lessees with an exemption from assessing whether a Covid-19-related
rent concession is a lease modification. The amendments require lessees that
have elected to apply the exemption to account for Covid-19-related rent
concessions as if they were not lease modifications. It may be noted that
accounting for lease modification can be very cumbersome and time consuming for
many lessees that have significant leases on their balance sheet. If the
modification accounting applies, a lessee does not recognise the benefits of
the rent concession in profit or loss straight away. Instead, the lessee will
recalculate its lease liability using a revised discount rate and adjust its
right-of-use assets. If the modification accounting does not apply, the profit
or loss impact of the rent concession would generally be more immediate.
The practical expedient in
many cases will be accounted for as a variable lease payment. If accounted for
as a variable lease payment, the concession is accounted for in profit or loss
in the period in which the event or condition that triggers those payments
occurs.
It may be noted that the
practical expedient is a choice and it is not mandatory to apply. The practical
expedient is not available to lessors. The practical expedient applies only to
rent concessions that meet all the following conditions (paragraphs 46A and
46B):
Condition 1
– The rent concession occurs as a direct consequence of the Covid-19 pandemic.
Condition 2
– The change in lease payments results in revised consideration for the lease
that is substantially the same as, or less than, the consideration for the
lease immediately preceding the change.
Condition 3
– Any reduction in lease payments affects only payments originally due on or
before 30th June, 2021.
Condition 4
– There is no substantive change to other terms and conditions of the lease.
Let’s take a few scenarios to
assess the applicability of the practical expedient.
ISSUE
Base fact
pattern
- Lessor leases commercial space to lessee,
- Lease term is four years and rental is fixed at Rs. 4,000 p.m.
Whether practical expedient
is available in the following scenarios?
|
Scenario
|
Facts
|
Can practical
expedient be applied?
|
|
1
|
- Year 2020: Rent is reduced
to Rs. 3,000 p.m. for May-July, 2020 due to business disruption as a result
of Covid-19
- No change in subsequent years and no other change in
lease contract
|
Yes, as rent concession is as a direct
consequence of the Covid-19 pandemic and all the other three conditions are
also met
|
|
2
|
- Year
2020: Rent is reduced to Rs. 3,000 p.m. for
May-July, 2020
- Year 2021: Rent for
Aug.-Oct., 2021 is increased by Rs. 1,000 p.m. from the original rent. B will
pay Rs. 5,000 p.m. for
Aug.-Oct., 2021
|
Yes, because reduction in lease payments affects
only payments originally due on or before 30th June, 2021.
Additionally, the increase in lease rental is beyond 30th June,
2021 and is in proportion to the concession provided. For Condition 3,
amendment acknowledges that a rent concession would meet this condition if it
results in reduced lease payments on or before 30th June, 2021 and
increased lease payments that extend beyond 30th June, 2021
|
|
3
|
- Lessor agreed for a six-month rent holiday from May – Oct., 2020, i.e.,
concession of Rs. 24,000
- However, in the month of March, 2021, the lessee pays this amount along with interest of Rs. 3,000, which totals to Rs. 27,000
|
Here, though there is a rent holiday, but those
rents are paid subsequently, along with interest. IASB has noted in their
basis of conclusion that if the cash flows have increased to compensate the
time value of money, it would appear to be appropriate for entities to assess
that Condition 2 is met. Other increases in consideration, such as penalties
that are included in the deferral, would cause this criterion to be not
satisfied
|
|
4
|
- Year 2020 & 2021: Rent is reduced to Rs. 3,000 p.m. for May, 2020 – Dec.,
2021
- Year
2022 & 2023: Rent for Jan. 2022 – Aug. 2023 is increased by Rs. 1,000
p.m. from original rent. B will pay Rs. 5,000 p.m. for Jan., 2022 – Aug., 2023
|
No. In this scenario, the rent reduction is as a
direct consequence of Covid. However, the reduction of Rs. 1,000 affects the
payments originally due for the period even beyond 30th June,
2021. The timeline prescribed in the amendment is purely rule-based. It would
not be appropriate to interpret it in such a way that rental concession can
be applied to the rent covering the period up to 30th June, 2021
and for rent changes beyond 30th June, 2021 the normal accounting
of lease modification can be applied. One should consider the changes in the
lease rentals in their entirety. It is not acceptable that rent concessions
are accounted such that one portion satisfies the criterion (i.e. May, 2020 –
June, 2021, i.e., 30th June is the date beyond which rent
concessions completely disqualify the entity from applying the accounting
relief) and the remaining portion, i.e., July, 2021 to August, 2023 does not
satisfy the criterion
|
|
5
|
- Year 2020: Rent is reduced to Rs. 3,000 p.m. for
May-July, 2020
- Year 2021: Rent for Aug.-Oct., 2021 is increased by Rs. 4,000 p.m. from original rent. B will pay Rs. 8,000 p.m. for
Aug.-Oct., 2021
|
No, because the reduction is of Rs. 1,000 in 2020
but in 2021 the rent increased by Rs. 4,000 from original rent which is not
in proportion to the concession provided
|
|
6
|
- Lessor offers to reduce the monthly rent on the condition that its space is
reduced from 8,000 sq. ft. to 5,000 sq. ft.
|
No, it would be a substantive change to other
terms and conditions, and therefore the practical expedient would be unavailable
for that rent concession
|
|
7
|
- Rent holiday for May-July, 2020
- At the end of the lease term, it gets extended for three months on the terms
and conditions contained in the original lease agreement
|
Yes, because the lease extension is not considered
as a substantive change to other terms and conditions of the lease. This
point has been clarified in basis for conclusion of the standard
|
Comparison
between applying the practical expedient and lease modification
Example –
rent abatement
Entity A leases retail space
from Entity B. As at 31st May, 2020, Entity B grants Entity A a
one-month rent abatement, where rent of Rs. 1 million that would otherwise be
due on 1st June, 2020 is unconditionally waived. The rent concession
satisfies the criteria to apply the practical expedient. The rent concession is
a lease modification because it is a change in consideration for a lease that
is not part of the original terms and conditions of the lease. The rent
concession meets the definition of a lease modification and it would be
accounted for as such if the practical expedient is not elected by Entity A.
|
|
Practical expedient not applied – lease
modification accounting (Ind AS 16.39 – 43)
|
Practical expedient is applied – variable lease
payment accounting [Ind AS 16.38(b)]
|
|
Effect on
lease liability
|
Reduced to
reflect the revised consideration
|
Reduced to
reflect the revised consideration
|
|
Effect on
discount rate
|
The total
revised, remaining consideration is re-measured using an updated discount rate
as at the effective date of the lease modification
|
No change
in discount rate
|
|
Effect on
right-of-use asset
|
The
offsetting adjustment is recorded against the carrying value of the
right-of-use asset
|
No effect
|
|
Effect on
profit or loss
|
None as at
the time of modification; but will result in modified finance expense and
depreciation in subsequent periods
|
The
offsetting adjustment is recorded in profit or loss
|
As is
visible from the above example, the practical expedient provides relief to the
lessee in the following ways:
(a) The lessee does not have to assess each rent
concession to determine whether it meets the definition of a lease
modification;
(b) It also simplifies the
calculations that are prepared by the lessee, since it does not require a revised
discount rate;
(c) The rent concession is accounted in profit or
loss in the period in which the event or condition that triggers the revised
consideration occurs, rather than being reflected in future periods as revised
finance expense and depreciation of the right-of-use asset.
CONCLUSION
The author believes that the
practical expedient is a welcome relief for lessees that have a large number of
leases, for example, airline, telecom, retail and other entities. However,
applying practical expedient may not be as simple as it appears and there could
be numerous complexities in determining what scenarios can be subjected to a
practical expedient, as well as the accounting of the practical expedient.
If the lessee applies the
practical expedient, it shall disclose if it has applied the expedient to all
lease contracts or the nature of the contracts to which it has applied the
expedient. The lessee should also disclose the P&L impact of applying the
practical expedient.
