IASB update on IFRS 16 Lease modification accounting under COVID-19

On Friday 17 April 2020, the Board considered a staff recommendation to publish an exposure draft proposing an amendment to IFRS 16 Leases related to COVID-19-related rent concessions.

 Background to the issue

The Board has been informed that many lessors around the world have provided, or are expected to provide, rent concessions to lessees as a result of the COVID-19 pandemic. This is particularly prevalent in the retail industry and, in some cases, is being encouraged or required by the government.

 In some cases those concessions are

• straight forgiveness of lease payments and
• in other cases the Lessee might make no payments for say three months now but make increased payments in future all have an additional three months added on to the end of the current contract. 

 The IFRS board believes rank concessions are occurring or are expected to occur in high volumes and across many IFRS jurisdictions as a result of the pandemic. IFRS 16 already tells companies how to account for these situations but the problem however is that applying the requirements to a potentially large volumes of COVID 19 related reconstructions could be practically difficult and that is especially true for lessees. 

 Complexity in applying the requirements arises in two main ways:

1. assessing whether rent concessions are lease modifications—this assessment requires consideration of whether the change in lease payments as part of the original terms and conditions of the lease. The prevalence of rent concessions during the COVID-19 pandemic makes this assessment difficult in two ways:
   • entities may need to assess a large volume of contracts; and
   • the assessment itself might be difficult. (For example, a lease contract or applicable law or regulation may contain clauses, such as force majeure, which were developed without contemplating the COVID-19 pandemic. It may be difficult to determine whether rent concessions offered—or mandated by government—are captured by the operation of such clauses).
2. applying the required accounting for rent concessions that are lease modifications—while this is not unduly onerous for an individual lease modification, the volume of leases subject to rent concessions arising from the COVID-19 pandemic may mean this accounting would occupy resources at a time when lessees are likely to have other, more significant, concerns to deal with arising from the pandemic.

 Brief recommendation on the exposure draft :

 The lessee has an option to apply for the exemption in lease modification related to COVID 19 consistently to contracts with similar characteristics and in similar circumstances. Such an exemption would:

• remove the practical challenge of possibly having to assess a large volume of contracts to determine whether a COVID-19-related rent concession is a lease modification;
• eliminate the need to remeasure lease liabilities using a revised discount rate for potentially large volumes of contracts thus simplifying the mechanics of the accounting;
• require lessees that apply the exemption to disclose that fact;
• require lessees to apply the exemption retrospectively, recognizing the cumulative effect of initially applying the amendment as an adjustment to the opening balance of retained earnings (or other component of equity, as appropriate) at the beginning of the reporting period in which a lessee first applies the amendment;
• still enable useful information to be provided to users of the financial statements; and
• The exemption would be applicable only to changes in lease payments arising as a direct result of the COVID-19 pandemic and occurring within a limited timeframe (affecting only reductions in payments originally due in 2020).

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Applicability of this recommendation

 This exemption applies only for the period of 2020 due to events arising out of COVID 19 and the reason is that as we do not know how long the pandemic will last and once the worst of the pandemic is over, the ongoing economic effects could last a long time and it could be left having to make very difficult judgments about what is and isn't directly related to COVID 19.  The Board thinks it is clear that the significant effects of the pandemic is happening now and by ring-fencing it  directly to 2020, it can take some of the pressure off those difficult judgments,  because if the stores are offering rent concessions as a result of the economic effects in the next few months, the Board believes that would be clear between the parties that that is the reason.

 Education materials issued on April 10

The Board had also issued education material related to IFRS 16 on April 10. This material is complementary to the proposed amendment to IFRS 16. Lessees who don’t want to avail the exemption or relief of lease modification accounting can continue to use the existing provisions of IFRS 16 and refer to the education material.

 Timelines

The proposed exemption described above will be of benefit to entities only if it is provided in a timely manner and hence The Board is expected to issue the exposure draft by April 27. This should enable the Board to finalize any amendment to IFRS 16 by the end of May 2020, which would expect to benefit many affected entities with a 31 March 2020 year-end and all affected entities with later year-ends.

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