Covid-19-related rent concessions: Amendment to IFRS 16

Introduction

The Covid-19 pandemic and the lockdown may have a significant impact on the ability of lessees to meet their lease obligations in paying rent. However, it may happen that the landlord has offered a “rent-holiday” of a few months. With the recent amendment, lessees now have a choice to either consider whether such a rent concession represents a “lease modification” or apply the practical expedient and elect not to consider whether the rent concession is a lease modification.

Assessing whether a change in payments is a lease modification

IFRS 16 defines a lease modification as a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease. In determining whether there has been a change in the scope of the lease, you have to consider whether there has been a change in the right of use conveyed to the lessee by the contract. For example, adding or terminating the right to use one or more underlying assets, or as in this situation extending or shortening the contractual lease term. It is crucial to note that a rent holiday in isolation is not a change in the scope of a lease.

In assessing whether there has been a change in the amount of the lease payments, one must consider the overall impact of any change in the lease payments. For example, if the lessee does not make lease payments for a three-month rent holiday, the lease payments after the three-month period would probably be increased by the landlord. This means that the consideration that the lessee would pay over the term of the lease would not change and would not represent a lease modification.

Applying the practical expedient (elect not to assess whether rent concession is a lease modification)

A lessee that makes this election shall account for any change in lease payments resulting from the rent concession the same way it would account for the change applying IFRS 16 if the change were not a lease modification.

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:

  • 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;
  • any reduction in lease payments affects only payments originally due on or before 30 June 2021 (for example, a rent concession would meet this condition if it results in reduced lease payments on or before 30 June 2021 and increased lease payments that extend beyond 30 June 2021); and
  • there is no substantive change to other terms and conditions of the lease.

Disclosure requirements when applying the practical expedient

The lessee shall disclose:

  • that it has applied the practical expedient to all rent concessions that meet the conditions as above or, if not applied to all such rent concessions, information about the nature of the contracts to which it has applied the practical expedient; and
  • 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 lessee has applied the practical expedient

Decision-Tree when opting NOT to apply the practical expedient

The Impact of Coronavirus on Financial Reporting and Preparers of the Annual Financial Statements

All preparers of Annual Financial Statements should consider the impact of the Coronavirus (COVID-19) on interim and annual financial statements.View PDF

The Impact of Coronavirus on Audits and the Considerations by Auditors

Auditors of Financial Statements (AFS) need to consider the following during their audits:

  • Impact of COVID-19 on the entity and its operations and reporting timelines.
  • Whether those charged with governance (TCWG) performed appropriate risk assessment procedures to prepare for the impact of COVID-19 on the entity and their assessment of the appropriateness of using the going concern basis of preparation.
  • Reconsider the impact of COVID-19 on the initial audit risk assessment and whether it should be revised in terms of ISA 315.
  • Design and performing specific procedures in terms of ISA 330 in response to the risks identified.
  • Whether there is a need to revise materiality in terms of ISA 320.
  • Assessing the financial impact involving accounting estimates made by management (estimation uncertainty due to significant assumptions including projected cash flows, risk assessment and audit evidence supporting these accounting estimates and related disclosure affected by COVID-19 event)

Note: If TCWG have determined that there is no material financial impact (or reasonably expected impact) on their entity, adequate disclosure regarding the key assumptions should be included in the AFS to support conclusion.

Examples of accounting estimates for financial impact:

  • Asset impairment / changes in assumptions for impairment testing
  • Changes in the useful life of assets
  • Change in FV of assets or NRV of inventory
  • Changes in ECL for loans and other financial assets
  • Increased costs and/or reduced demand for products and services affecting impairment calculations and / or requiring recognition of provisions
  • Potential provisions and contingent liabilities arising from fines and penalties
  • Uncertainty that cast significant doubt on the ability to continue as going concern (unknown duration of the impact)

 

  • Assessment whether the disclosures are material to the AFS and whether it is sufficient and appropriate for the users of the AFS – If no sufficient disclosures in the AFS, the auditor needs to consider the implications on the audit report in terms of ISA 705.
  • Consider whether COVID-19 and impact of this event is a matter of most significance in the audit and if there is a need to raise a Key Audit Matter (KAM) in accordance with ISA 701.
  • Subsequent events – Consideration whether COVID-19 event should be seen as an adjusting or non-adjusting event in the AFS (with adequate disclosure in the AFS regarding the nature and the impact).
  • Going concern – Evaluate the appropriateness of management’s use of going concern basis of accounting in preparing its financial statements. If it is concluded that the basis of accounting used to prepare the AFS is inappropriate or there are insufficient disclosures in the AFS, the auditor needs to consider these implications for the audit report in terms of ISA 705.
  • For listed entities – review other information in accordance with ISA 720 and consider whether there are any material inconsistencies between the other information included in the annual report and the AFS.
  • Group reporting – consider the impact how COVID-19 may impact risk assessment, materiality and ability to obtain appropriate audit evidence – If adequate information cannot be obtained from the components, the group auditor should consider these implications on the audit report in terms of ISA 705.

Determine the following:

  1. Is the risk assessment performed by management (if any) and the impact thereof on the financial statements appropriate?
  2. Did management assess whether the subsequent event should be treated as adjusting or non-adjusting event (with relevant disclosures in the AFS) and is the assessment appropriate?
  3. Do you agree with management’s assessment as to the appropriateness of the going concern basis of preparation?
  4. Is the disclosure in the financial statements adequate?

YES – Perform appropriate audit procedures to support above

NO – Consider possible impact on the audit report in terms of ISA 705 (if material)

IFRS 16 Leases: Transition choices

Retrospective approach

Under the retrospective approach, a company applies the new standard retrospectively in accordance with IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors. Comparatives also need to be restated.
Changes in accounting policies

An entity is permitted to change an accounting policy only if the change: is required by a standard or interpretation. [IAS 8.14]

Retrospective application means adjusting the opening balance of each affected component of equity for the earliest prior period presented and the other comparative amounts disclosed for each prior period presented as if the new accounting policy had always been applied. (In other words: restate prior financial information) [IAS 8.22]

Modified (Simplified) Approach

Under the simplified approach, a company applies IFRS 16 from the beginning of the current period. This requires the following:

  • Calculating lease assets and lease liabilities as at the beginning of the current period using the unique rules included in IFRS 16.
  • Do not restate prior-period financial information.
  • Recognising an adjustment in equity at the beginning of the current period – depending on the unique rules included in IFRS 16.

Unique Rules

Adjustment to equity at beginning of current period (See Module 1)

This applies when:

  • The lease was previously classified as operating lease and continues under IFRS 16.
  • Management wants to reflect that IFRS 16 had always been applied.

No adjustment to equity at beginning of current period (See Module 2)

This applies when:

  • Right-of-use (ROU) asset is based on the present value of remaining lease payments.

The Retrospective and Simplified approaches are best illustrated by way of example:

Understanding the amendments to the definition of IFRS Materiality

Effective for annual periods beginning on or after 1 January 2020 – earlier application is permitted.

In October 2018, the IASB amended the definition of “material” in IAS 1 Financial Statement Presentation and IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors to applicable through all IFRS Standards to make it easier for entities to make material judgements.

Practice Statement 2 and the TIP issued March 2017 provides further guidance in applying materiality.

Obscuring information

Five ways material information can be obscured:

  • if the language regarding a material item, transaction or other event is vague or unclear;
  • if information regarding a material item, transaction or other event is scattered in different places in the financial statements;
  • if dissimilar items, transactions or other events are inappropriately aggregated;
  • if similar items, transactions or other events are inappropriately disaggregated; and
  • if material information is hidden by immaterial information to the extent that it becomes unclear what information is material.

Information is material if omitting, misstating or obscuring it could reasonably be expected to influence the decisions that the primary users of general purpose financial statement make on the basis of those financial statement, which provide financial information about a specific reporting entity.

Obscuring

The previous definition only focused on omitting or misstating information. Obscuring material information with superfluous information that can be omitted information that can be omitted may distract the primary may distract the primary may distract the primary users from the ability to differentiate between what information is material and what not information is material and what not. Although the term . Although the term obscuring is new in the definition, it was already part of IAS 1 (IAS 1.30A).

Primary Users

The existing definition referred only to ‘users’ which again might be understood too broadly as requiring to consider all possible users of financial statements when deciding what information to disclose. Primary users include shareholders, investors, creditors, lenders and government.

Could reasonably be expected to influence

The previous definition referred to ‘could influence’ which might be understood as requiring too much information as almost anything ‘could’ influence the decisions of some users even if the possibility is remote.

Decisions

Replacing the term ‘economic decisions’ with ‘decisions’: decisions may have a wider application than only economic decisions as primary users do not only make decisions about their investments when they interpret financial statements.