Not-for-profit (NFP) entities may be granted the right to lease an asset for a nominal amount of consideration. These leases are commonly known as ‘peppercorn leases’. This issue of AASB 16 Check responds to the question we are hearing from NFP lessees on the measurement of the right-of-use (ROU) asset in a peppercorn lease, under AASB 16 Leases.
A NFP entity enters into a lease for office space. The lessor provides the office space for a nominal lease payment of $1 p.a. Market rent for the space is $100,000 p.a. The lease term is 5 years.
Question: Is the NFP entity required to measure the ROU asset at fair value?
Interpretive response: No. An amendment to the leases standard in December 2018 provides the NFP entity the choice of measuring the ROU asset for its peppercorn lease at cost or at fair value. Under either option, the lease liability will be recorded at the present value of $5 (5 years x $1 p.a. – nominal amount).
Option 1: Measuring the ROU asset at fair value
Measuring the ROU asset at fair value will result in the ROU asset being recognised at the present value of $500,000 (5 years x $100,000 p.a.), and the difference between the lease liability and ROU asset being recognised in the income statement in accordance with AASB 1058 Income of Not-for-Profit Entities.
Option 2: Measuring the ROU asset at cost
Measuring the ROU asset at cost will mean that the ROU asset will equal the lease liability, i.e. be recognised at the present value of $5 (5 years x $1 p.a.). Where the ROU asset is measured at cost additional disclosures around the entity’s dependence on such leases must be disclosed. This will include the nature and terms of such leases, including any restrictions on the use of the underlying assets by the entity.
This choice of measurement is available both on transition to AASB 16 Leases and for any new peppercorn leases entered into after transition.
One of the main reasons the cost option was provided was the recognition of the practical difficulties NFPs face in measuring the fair value of such right-of-use assets – as it is not the fair value of the underlying asset that is being measured. Our Reporting Update 19RU-001 includes further details.
Notwithstanding paragraphs 23–25, where the lessee is a NFP entity, the lessee may elect to measure ROU assets on a class-by-class basis at initial recognition at fair value in accordance with AASB 13 Fair Value Measurement for leases that have significantly below-market terms and conditions principally to enable the entity to further its objectives. AASB 1058 Income of Not-for-Profit Entities addresses the recognition of related amounts. [AASB 16: Aus25.1]
If you would like to discuss the implementation of the new standard for your organisation, please contact us.