Many lessees have requested rent concessions from lessors over the past year. Rent concessions may include a one-off rent reduction, rent waivers or deferrals of lease payments. Here we respond to a common question we are hearing about rent concessions which affect prior periods.
Company A enters into an agreement to rent office space in a building for three years on 1 January 2020. Lease payments are $2,000 per quarter, payable at the beginning of each quarter. The incremental borrowing rate applicable for this lease is 3.75% per annum. Lease liability schedule for the first year of the lease is as follows:
Company A’s business is significantly impacted by COVID-19. It started to negotiate rent concessions in April 2020 with the lessor. Although negotiations were not finalised until 1 October 2020, Company A paid only 70% of the rent due for the quarters beginning 1 April 2020 and 1 July 2020. There are no penalties or additional interest charges for late lease payments.
As a result, the lease liability schedule as at the financial year ended 30 June 2020 was as follows, as Company A is required to continue to accrue interest expense as per the original terms until the rent concession arrangement is formalised.
*1. Lessees should have accrued interest expenses as per the original terms until the rent concession arrangement is formalised between the lessor and lessee. Interest expense for the period April to June 2020 would be $180 (i.e. 60+60+60).
*2. The total amount payable to the lessor would be $19,663 (i.e. $19,063 + accrued payable of $600).
*3. The total amount payable to the lessor as at 30 June 2020 would be $19,782 (i.e. $19,182 + accrued payable of $600).
*4. Companies may continue to recognise such amounts as lease liabilities instead of separating out as Accrued Payables.
On 1 October 2020, the lessor agreed to provide Company A with a 30 percent rent relief for the nine months starting from April 2020 to December 2020. Company A decides to apply the practical expedient to account for the rent concession.
Question: What is the accounting impact for Company A when the terms of the rent concession were agreed on 1 October 2020?
The lease liability will be remeasured based on the agreed modified lease payments as at the date when the rent concession is formalised. The updated lease liability schedule from 1 October 2020, (until 31 January 2021) is presented below.
*5. $16,744 is the present value of lease liability as at 1 October 2020 based on the revised lease payments for the lease term.
As Company A is applying the practical expedient for rent concessions, the difference between the carrying amount of the original lease liability on 1 October 2020 of $17,344 (see Table 1) and the revised lease liability of $16,744 is recognised in profit or loss, similar to variable rent expense.
Dr. Lease Liability $600
Cr. Variable rent expense $600
Further, the $1,200 owing from the April and July 2020 lease payments recognised as part of Accrued Payables is also recognised as a rent concession in profit or loss as follows:
Dr. Accrued Payables $1,200
Cr. Variable rent expense $1,200
The amendments to AASB 16 introduce an optional practical expedient that simplifies how a lessee accounts for rent concessions that are a direct consequence of COVID-19. A lessee that applies the practical expedient is not required to assess whether eligible rent concessions are lease modifications, and accounts for them in accordance with other applicable guidance. The resulting accounting will depend on the details of the rent concession.
For example, if the concession is in the form of a one-off reduction in rent, it will be accounted for as a variable lease payment and be recognised in profit or loss.
The practical expedient will only apply if:
* The International Accounting Standards Board decided on 4 February 2021 to propose to extend the practical expedient. Under the proposed extension, the practical expedient would remain available for a further 12 months. That is, the practical expedient would apply to rent concessions if the reduction in lease payments relates to payments due on or before 30 June 2022. An exposure draft was issued on 11 February 2021, with an accelerated comment period of 14 days. The deadline for submissions is 25 February 2021.
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