Covid-19 has impacted many businesses worldwide. As declared by World Health Organization (WHO), the pandemic has not only taken lives but has aggravated many other issues such as hunger, climate change, unemployment, population growth, etc. These testing times required testing measures by the Governments and Regulators. The accounting fraternity was not any different. The International Accounting Standards Board (IASB), the apex authority for the preparation and issuance of International Financial Reporting Standards (IFRS), has issued various amendments, guidelines, and clarifications on applying IFRS. These amendments were issued to support businesses to capture financial reporting transactions during these exceptional circumstances appropriately.
Among the amendments issued, one of the critical amendments was in IFRS 16 “Leases” for rent-related concessions. Businesses using leased properties witnessed a significant reduction in consumers, shoppers, and some businesses closed down during the Covid-19. Considering these unusual circumstances, many lessors provided rent related concessions to their lessees to support their businesses in rent related concessions. The concessions included either deferring or relieving the lessee with the amount that would otherwise be payable by them. These may be through one-on-one negotiation or as a consequence of government encouraging or requiring that relief to be provided to businesses.
To cater to the accounting implications of these concessions, IASB amended IFRS 16 in the following manner:
- Allowed the lessees with an exemption from assessing whether a Covid-19 related rent concession is a lease modification
- Allowed the lessees to apply the exemption to account for Covid-19 related rent concessions as if they were not lease modifications
- Allowed lessees to provide a disclosure related to applicability of the exemption
- Allowed lessees to apply for the exemption retrospectively under IAS 8 but not require them to restate prior period figures
The above amendments apply only to rent related concessions occurring as a direct consequence of Covid-19 for a period until June 2021 only if there are no substantive changes to the lease agreement’s other terms and conditions.
Shop A leases space in a shopping mall from Lessor B. Shop A makes fixed lease payments to Lessor B of GBP 600 semi-annually in arrears under the lease. The non-cancellable lease term starts on 1 January 2020 and ends on 30 June 2021. The contract does not include any non-lease components, extension, termination, or purchase options. The discount rate is 5% on the commencement date.
Due to the Covid-19 pandemic, on 1 July 2020, Lessor B agrees to defer the lease payment originally due on 31 December 2020 to 30 June 2021. There are no other changes to the terms and conditions of the lease.
Assumption: Shop A’s right-of-use asset is not impaired before or during the periods described.
First thing first, Shop A needs to assess whether the rent concession qualifies for the practical relief provided by IFRS 16. To qualify for the relief, the rent concession should be granted as a direct consequence of the Covid-19 pandemic and should result in no substantive change in the lease payments for the lease. The reduction in lease payments should also only affects the payments that were originally due on or before 30 June 2021. As there are no other changes to the terms and conditions of the contract, Shop A concludes that the conditions of Rent Related Concessions are met.
Approach 1 – Account for the deferral in the lease as a negative variable lease payment
On 1 July 2020, Shop A will treat the concession as an event or condition which triggers a negative variable payment. Shop A derecognizes the part of the lease liability, which is the time value of money of the lease payment deferred using the unchanged discount rate with the adjustment in profit or loss.
Lease liability immediately before the rent concession:
Present value of lease payments discounted at 5% = GBP 1,157 (600/(1.05)1/2 + 600/1.05)
Lease liability immediately after the rent concession:
Present value of lease payments discounted at 5% = GBP 1,143 (1,200/1.05)
Dr Lease liability (1,157-1,143) GBP 14
Cr Profit or loss GBP 14
To record the reduction in lease liability arising from the rent concession. Depreciation of the right-of-use asset continues over the remaining lease term.
Approach 2 – Account for the deferral as a resolution of a contingency that fixes previously variable lease payments
The accounting under this approach would be the same as under Approach 1 above, except that the credit of GBP 14 would be recognized as an adjustment to the right-of-use asset, rather than a credit to profit or loss.
Approach 3 – Account for the deferral of lease payments as if the lease is unchanged
In this approach, Shop A continues to account for the lease liability and right-of-use asset using the existing lease’s rights and obligations. The lease payment initially due on 31 December 2020 will remain on the balance sheet until it is settled on 30 June 2021, but the amount will not accrue interest during the deferral period. Hence, the interest expense for the six months up to 30 June 2021 will remain the same as in the original amortization schedule. Depreciation of the right-of-use asset continues over the remaining lease term.
The impacts of Covid-19 are far-reaching and are still evolving. These circumstances are not expected. Instead, they have given rise to a new normal situation. Management needs to understand this new normal and provide accurate and reliable information to its stakeholders to understand the impacts of Covid-19 on the Company truly. The second wave of Covid-19 is round the corner, and several countries, are moving towards a complete lockdown. Businesses will likely suffer more, and we may see more concessions or discounts or other facilities provided to keep the wheel rolling. The regulators will now also have to play their part and develop policies and guidelines to enable the businesses to address the new normal.