The timing of operating lease payments does not always evenly match the periods in which lessees are granted the right to use the leased asset, for example 'rent-free periods'. Under current leases standards, prepaid rent or accrued liabilities are recognised in order to 'straight-line' lease payments. This issue of AASB 16 Check responds to the common question we are hearing on existing ‘straight-lining’ accounts and AASB 16 Leases.
Let’s pose a scenario that prior to the implementation of AASB 16, a company has an existing operating lease of office space. The company recognises rent expense on a straight-line basis over the lease term, and the timing of lease payments does not represent the time pattern of the lessee’s benefits. The company therefore has a ‘straight-lining’ prepaid rent account, recognised on the balance sheet.
Question: On transition to AASB 16, what happens to the existing operating lease straight-lining prepaid rent account currently recognised on the balance sheet?
Interpretive response: The straight-lining prepaid rent account is capitalised as part of the right-of-use asset on transition. If there had been a straight-lining accrued liability on transition, this would have reduced the right-of-use asset on transition – where the modified retrospective approach is applied. This adjustment only occurs where the option of initially measuring the right-of-use asset at an amount equal to the lease liability is chosen. There is no adjustment to opening retained earnings.
When the right-of-use asset is measured retrospectively there may be an adjustment to opening retained earnings.
The straight-lining account is either a prepaid lease payment (cash paid before the expense is recognised), or an accrued lease payable (lease expense recognised before the cash has been paid).
Under the modified retrospective transition method, the lessee measures the lease liability at the present value of the remaining lease payments at the date of initial application. Under this method, the right-of-use asset is either measured at an amount equal to the lease liability, adjusted by the amount of any prepaid or accrued lease payments relating to that lease, recognised in the statement of financial position immediately before the date of initial application; or at the carrying amount as if the standard had always applied, but discounted using the lessee’s discount rate at the date of initial application [AASB 16: C8(b)].
If you would like to discuss the implementation of the new standard for your organisation, get in touch.