On 28 May 2020, the International Accounting Standards Board (the IASB® Board) finalised an amendment to IFRS 16 Leases that allows a lessee to by-pass the need to evaluate whether certain qualifying COVID-19-related rent concessions are "lease modifications". The Hong Kong Institute of Certified Public Accountants (HKICPA) is expected to issue an equivalent amendment to HKFRS 16 shortly. This one-off relief is available for immediate application and impacts the period over which a lessee recognises the profit or loss effects of qualifying rent concessions.
This issue of the Financial Reporting Hot Topics newsletter summarises the IFRS 16 amendment (and the equivalent HKFRS 16 amendment), and explains the qualifying criteria and other considerations on whether and how to take advantage of the one-off relief.
IFRS 16 contains requirements that specify the accounting for changes in lease payments, including rent concessions. Applying those requirements to a large volume of COVID-19-related rent concessions could be practically difficult, especially when the determination involves legal interpretation or when a modification necessitates the re-measurement of lease liabilities using revised discount rates.
In light of the potential practical challenges, the amendment to IFRS 16 allows lessees, as a voluntary practical expedient, not to assess whether particular COVID-19-related rent concessions are lease modifications and, instead, account for those rent concessions as if they were not lease modifications.
The diagram below highlights how the amendment (highlighted in orange) interacts with the original requirements in IFRS 16. Lessees shall apply the practical expedient consistently to contracts with similar characteristics and in similar circumstances.
The practical expedient is not available to lessors.
The amendment is effective for annual reporting periods beginning on or after 1 June 2020. Earlier application is permitted. Changes arising from applying the amendment are accounted for retrospectively, with the cumulative effect of initially applying the amendment recognised as an adjustment to the opening balance of retained earnings at the beginning of the annual reporting period.
In practical terms, that means:
A lessee applying the practical expedient shall disclose that it has applied the practical expedient to all qualifying COVID-19-related rent concessions or, if not applied to all such rent concessions, information about the nature of the contracts with similar characteristics and in similar circumstances to which it has applied the practical expedient. In addition, the lessee shall disclose the amount recognised in profit or loss for the reporting period to reflect changes in lease payments that arise from rent concessions to which the practical expedient has been applied.
The practical expedient applies only to rent concessions occurring as a direct consequence of the COVID-19 pandemic, and only if all of the following conditions are met. It may not be analogised to in other circumstances:
(a) 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;
(b) Any reduction in lease payments affects only payments originally due on or before 30 June 2021; and
(c) There is no substantive change to other terms and conditions of the lease.
The following examples illustrate the evaluation of different rent concessions against the qualifying criteria.
In all of the following examples, it is assumed that the rent concession is a direct consequence of the COVID-19 pandemic. A rent concession that is not a direct consequence of the COVID-19 pandemic is not eligible for the practical expedient. For example, if a tenant in Hong Kong agreed with its landlord in early January 2020 that a 20% rent rebate for November – December 2019 is offered due to the business disruption from social event, such rent concession does not qualify for the practical expedient as it is not a direct consequence of the COVID-19 pandemic.
Due to the significant drop in the retail sales after the Chinese New Year (CNY), a tenant approached the landlord in early February for a rent concession. The landlord compared the trade of the retailer before and after the CNY and expected its business might not be recovered very soon due to the pandemic. As a result, in order to maintain a good relationship with the tenant, the landlord agreed to cut the rent of March and April by 50%. The remaining monthly payments and the lease term remain unchanged.
The tenant evaluates the concession against the three criteria as follows:
Accordingly, the tenant concludes that the rent concession is within the scope of the practical expedient.
A tenant’s business has been severely impacted by the outbreak of COVID-19 since the CNY. After negotiation with the landlord, the tenant is offered a three-month rent holiday for April – June 2020 amounting to HK$100,000 in total. However, an additional payment of HK$100,000 on top of the monthly rent will be charged at the end of the lease term in June 2021.
The tenant concludes that the concession qualifies for the practical expedient. Among other things, the tenant notes that:
Same fact pattern as example 2, except that the landlord charges additional lease payments of HK$104,000 instead of HK$100,000 at the end of the lease in June 2021 to reflect the time value of money.
|The tenant concludes that the concession qualifies for the practical expedient when evaluated against the three criteria. In addition to the considerations set out in example 2 above, the tenant notes that the additional HK$4,000 charged by the landlord is to reflect only the time value of money from the deferral of lease payments for April – June 2020, and hence the revised consideration for the lease is still substantially the same with the original consideration.|
After negotiation with the landlord, the rent in April – June 2020 is waived, amounting to RMB30,000 in total. At the same time, three months’ fixed term is added immediately after the original expiry date of the lease (i.e. extended to 30 June 2023) and it is also charged at a rent of RMB10,000 per month.
The manufacturer concludes that criteria (a) and (b) are clearly met. However, a judgement is required on assessing criterion (c), i.e. whether the 3 months’ lease extension is a substantive change to the lease.
Considering the facts that the 3-month lease extension is agreed in exchange for the grant of the 3-month rental waiver and the extension period is relatively unsubstantial compared to the remaining lease term, the lease extension is not considered as a substantive change to other terms and conditions of the lease. Accordingly, the deferral of the lease payments for April-June 2020 together with the extension of the lease term is within the scope of the practical expedient.
Whether the modification accounting applies to a rent concession could significantly impact the profit or loss profile of a lessee:
As indicated at the outset, evaluating whether a rent concession is a lease modification and if so the resulting modification accounting could be costly in a complex lease portfolio. Lessees have to weigh the costs and benefits of electing to apply the practical expedient.
Partner, Head of Professional Practice/Capital Markets
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Principal, Department of Professional Practice
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Director, Department of Professional Practice
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