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26 March 2020

What’s the issue?

Due to the impact of the COVID-19 coronavirus outbreak on trading conditions, many lessees are seeking rent concessions from lessors. Rent concessions may take the form of a one-off reduction in rent, a reduction for a defined period of time or a change in the nature of rent – e.g. fixed rent payments becoming variable. For example, a number of retailers are seeking reductions in real estate rents – though similar issues may arise in other leases.

The accounting implications of an agreed change to rents can be very different depending on whether the change was envisaged in the original lease agreement:

  • a rent concession not envisaged in the original lease agreement will often be a lease modification, requiring the lessee to remeasure lease assets and lease liabilities, and the lessor to revise its operating lease income over the remaining lease term; but 
  • the application of an existing contractual mechanism to adjust rent may represent a variable lease payment, resulting in an adjustment to lease income/expense in the period in which it arises.

Other considerations may apply if the lessee defaults on the lease or governments intervene to provide relief to lessors or lessees.

Significant judgement may be required to determine how to account for rent concessions in real estate and other leases.

Getting into more detail


Determining the nature of a rent concession

To account for a rent concession under IFRS 16 Leases, companies first need to determine the nature of the rent concession.

Many rent concessions will meet the definition of a lease modification – i.e. a change in scope or consideration that was not part of the original terms and conditions of the lease. When this is the case, companies apply the detailed guidance in IFRS 16 on accounting for lease modifications (see below).

In other cases, the original terms and conditions of the lease may include a mechanism to adjust rents if certain events occur. When this is the case, the rent concession will often represent a variable lease payment. Companies generally account for variable lease payments as income or expense in the period in which they arise.


Accounting for a rent concession that is a lease modification


To take a simple example, suppose a retailer leases a store from a landlord for a fixed term. The landlord classifies the lease as an operating lease. The retailer and landlord negotiate a change in the terms and conditions of the lease, so that the fixed rent is reduced by 50% for the next 12 months. There are no other changes to the lease. 

The retailer and landlord account for this rent concession as follows.

  • The retailer recalculates its lease liability, by discounting the new rent at a revised discount rate determined at the date the lease modification was agreed. The retailer adjusts the right-of-use asset by the amount of the resulting change in the lease liability.
  • The landlord recalculates the straight-line operating lease income that it will recognise over the remaining term of the lease, based on the reduced rents. The landlord includes in this calculation any prepaid or accrued rents at the date the lease modification is agreed.

Accounting for lease modifications can be complex. Further guidance is available in our publication Lease modifications.


Other scenarios

In some cases, the government may intervene to provide support to lessees or lessors. When this is the case, companies should consider the guidance in IFRS® Standards on government assistance.

In addition, lessors should consider whether:

  • operating lease receivables are impaired;
  • underlying assets measured at cost are impaired; and
  • underlying assets measured at fair value – e.g. investment property measured at fair value – are appropriately measured.

Disclosures

Companies are required to disclose information about the effect that leases have on their financial position, financial performance and cash flows – including information about variable lease payments recognised as income/expense in the period. [IFRS 16.51, 89]

Actions for management to take now

  • Review existing lease contracts to identify whether they contain rent adjustment clauses that may be triggered in the current conditions.
  • Develop processes for real estate teams to report rent concessions to the finance function as they are negotiated and agreed. 
  • Identify and document key judgements made – e.g. in assessing the nature of the rent concession and, where relevant, determining the revised discount rate.
  • Consider expanding disclosures on the accounting impact of rent concessions as a result of the outbreak.

 

The International Accounting Standards Board has published educational material on rent concessions in the context of COVID-19. It is also proposing relief to lessees on rent concessions directly related to COVID-19. Read our web article.

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