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.

 

An overview of Accounting Estimates (ISA 540)

With financial reporting frameworks requiring more complex accounting estimates with high estimation uncertainty, auditors have increased responsibility when it comes to the auditing of these estimates and its related disclosures in the financial statements.

1.   Main components of an estimation process

The 3 main components in the process when determining accounting estimates are:

Methods & models – prescribed/alternative/self-developed/licensed/acceptable industry methods/consistency/complexity/subjectivity

Assumptions Data – significance/consistency/complexity/subjectivity nature/source/volume/relevance/reliability/accuracy/completeness/consistency/integrity during processing/complexity/subjectivity

2.   Auditor’s responsibilities when auditing accounting estimates

The key changes in the audit process around accounting estimates and the possible impact on management are indicated in the table below:

Management should expect the following questions to be asked by auditors about the estimation process:

  • What are your control processes around accounting estimates?
  • How are relevant significant transactions, conditions or events communicated to the person(s) responsible for making the accounting estimate(s)?
  • Do you review the outcome(s) of previous accounting estimates and how do you respond to the results of the review?
  • How is compliance with your financial reporting framework requirements regarding accounting estimates achieved?
  • How are regulatory factors relevant to the accounting estimates accounted for?
  • How is the need for specialized skills, including the use of a management expert, identified and applied?
  • What is your risk assessment process to identify and address risks relating to accounting estimates?
  • How do you identify the relevant methods/models, assumptions and data in the estimation process? How do you determine the need for changes in them?
  • How to you address the degree of estimation uncertainty in selecting your final point estimates?
  • How do you describe these processes for deriving your accounting estimates and degrees of estimation uncertainty in the financial statements (disclosures)?
  • Is there oversight and governance in place over the financial reporting process of accounting estimates?

3.   Management responsibilities in determining when accounting estimates are needed

Determining whether accounting estimates are needed require proper processes and controls to identify any transactions, events or conditions that give rise to such estimates. The need for accounting estimates will depend on the nature of the entity, the environment, transactions entered into and other events, conditions or circumstances.

Management would need to think about (1) transactions that require accounting estimates or changes to them and (2) conditions/events that may require accounting estimates or changes to them.

Guidance on the IFRS 15 requirements relating to Contract Costs

Whilst IFRS 15 is primarily a standard on revenue recognition, it contains specific requirements relating to contract costs. Companies may therefore need to change their accounting for those costs on adoption of IFRS 15 for annual reporting periods beginning on or after 1 January 2018. View PDF

Approval of Company Financial Statements

The South African Companies Act has specific requirements on the approval of financial statements.

Section 30(3) of the Companies Act states the following:
“The annual financial statements of a company must:
a. Include an auditor’s report, if the statements are audited;
b. Include a report by the directors with respect to the state of affairs, the business and profit or loss of the company, or the group of companies…
c. Be approved by the board and signed by an authorised director; and
d. Be presented to the first shareholders meeting after the statements have been approved by the board.”

ISA 560.5(b) defines the date of approval of the financial statements as follows:
“The date on which all the statements that comprise the financial statements, including the related notes, have been prepared and those with the recognized authority have asserted that they have taken responsibility for those financial statements.”

The act of approval of the financial statements requires the completion of the following 2 steps:

  1. The board of directors must approve the financial statements; and
  2. The financial statements must be signed by a director who has been authorised by the board to do so.

If any of these steps are not completed, the act of approval has not occurred.

Note: If there is a change in the board of directors subsequent to year end but before the Annual Financial Statements (‘AFS’) are approved, the directors at the time of sign-off should approve and sign the AFS as they are the empowering directors at the time of sign-off.

The ISAs further require that the auditor’s report be dated no earlier than the date on which the auditor has obtained sufficient appropriate audit evidence on which to base the auditor’s opinion on the financial statements.

Therefore, only once section 30(3)(c) of the Companies Act was satisfied, i.e. once the financial statements were approved by the board of directors and signed by an authorised director, will the auditor be able to date and sign the auditor’s report on the financial statements.

Note:

Audit documentation

Sufficient appropriate audit evidence of the following should be included in the audit file:

  • Approval process of the AFS
  • Evidence of the authorised director to sign the AFS (through inspection of minutes)
  • Evidence of the final set of AFS signed by the authorised director and should be marked as “final version”
  • Evidence of review of the final AFS
  • Final signed auditor’s report

The audit documentation must include identifying characteristics to allow an experience auditor, having no previous connection with the audit, to clearly identify the final and approved version of the company’s AFS and the final signed version of the auditor’s report in the audit file.

The draft versions of the financial statements should be removed from the audit file and only the final version should be placed on the audit file. It is recommended that a final version properly referenced to the lead sheets and the approved financial statements be kept on the final audit file.

Understanding low value assets

The IASB has developed IFRS 16 as a new leases Standard which supersedes IAS 17. A company is required to apply the new leases from 01 January 2019.

An exemption to the requirements of IFRS 16 relates to leases of ‘lowvalue’ assets held by the entity.

IFRS 16 does not require a company to capitalise leases of lowvalue assets—for example, leases of assets that, at the time of issuing IFRS 16, would have a capital value (i.e new sales price) of approximately US$5,000 (converted to approx. R70,000) or less.

Note: A company using this exemption is required to recognise the payments for those leases as an expense typically on a straight-line basis over the lease term. This results in no change to the accounting for those leases treated as off balance sheet leases applying IAS 17.

The correct determination of what constitutes a low-value asset within an entity is an activity which requires significant time and attention and which can have a significant impact on the transition from IAS 17 to IFRS 16.

1. Identification of low-value assets

It is important to note that the standard itself does not provide detailed guidance to assist in assessing what ‘low-value’ means. ‘Low-value’ is also not a defined term within the Standard itself.

The Basis for Conclusions of IFRS 16 provides the following insight and guidance regarding the type of leases to which the exemption is intended to apply:

“The IASB intended the exemption to apply to leases for which the underlying asset, when new, is of low-value (such as leases of table and personal computers, small items of office furniture and telephones). At the time of reaching decisions about the exemption in 2015, the IASB had in mind leases of underlying
assets with a value, when new, in the order of magnitude of US$5,000 or less”.

2. Assessment of ‘low-value’ assets

When making the assessment of what is low-value, the standard requires the lessee to assess the value starting from the value of the underlying asset when it was new, regardless of the age of the asset at inception of the lease.

It is important to note that the outcome of the assessment of whether an underlying asset is of low-value should not be affected by the size, nature, or circumstances of the lessee – ie the exemption is based on the value, when new, of the asset being leased; it is not based on the size or nature of the entity
that leases the asset.

3. Which assets may not be low-value assets?

Meeting the nominal threshold requirement alone is not in itself sufficient to warrant the classification of any particular asset as a ‘low-value’ asset.

IFRS 16 does not permit a lessee to break an asset down into many underlying assets of low-value unless:

  • The lessee can benefit from use of the underlying asset on its own or together with other resources that are readily available to the lessee, and
  • The underlying asset is not highly dependent on, or highly interrelated with, other assets.

Where a lessee sub-leases an asset, or expects to sub-lease an asset, the head lease cannot qualify as a lease of a low-value asset.

Note: A company using this exemption is required to recognise the payments for those leases as an expense typically on a straight-line basis over the lease term. This results in no change to the accounting for those leases treated as off balance sheet leases applying IAS 17.

Note that the recognition of a right-of-use asset and corresponding lease liability on the balance sheet is likely to lead to improved EBITDA. This may result in some entities electing not to apply the exemption.

Classification of Cash Flows

Cash receipts and cash payments must be classified as operating, investing, or financing activities on the basis of the nature of the cash flow.

Cash flows should be grouped into operating, investing or financing activities to enable investors and creditors to evaluate significant relationships within and between those activities.

Investing Activities

Investing activities include making and collecting loans and acquiring and disposing of debt or equity instruments and property, plant, and equipment and other productive assets, that is, assets held for or used in the production of goods or services by the entity (other than materials that are part of the entity’s inventory). Investing activities exclude acquiring and disposing of certain loans or other debt or equity instruments that are acquired specifically for resale.

Financing activities

Financing activities include obtaining resources from owners and providing them with a return on, and a return of, their investment; receiving restricted resources that by donor stipulation must be used for long-term purposes; borrowing money and repaying amounts borrowed, or otherwise settling the obligation; and obtaining and paying for other resources obtained from creditors on long-term credit.

Certain cash receipts and payments may have aspects of more than one class of cash flows. In such circumstances, entities must determine the appropriate classification by considering when to (1) separate cash receipts and cash payments and classify them into more than one class of cash flows and (2) classify the aggregate of those cash receipts and payments into one class of cash flows based on predominance.

Operating Activities

Operating activities include all transactions and other events that are not defined as investing or financing activities. Operating activities generally involve producing and delivering goods and providing services. Cash flows from operating activities are generally the cash effects of transactions and other events that enter into the determination of net income.

Specific Considerations

  • Changes in a parent’s ownership interest while the parent retains its controlling financial interest in its subsidiary should be accounted for as equity transactions (investments by owners and distributions to owners acting in their capacity as owners). Accordingly, payments to acquire noncontrolling interests in a subsidiary, or those associated with the sale of noncontrolling interests in a subsidiary, should be classified as financing activities in the statement of cash flows.
  • An entity that actively and frequently purchases, sells, or trades equity securities, intending to sell them in the near term (e.g., hours or days) to generate short-term profits, would generally present such cash flow activity as operating activities; otherwise, presentation within investing activities would generally be required.
  • When an entity pays for capital expenditures or operating expenses before the reimbursement of government grant monies, it should present the receipt of the government grant in the statement of cash flows in a manner consistent with the presentation of the related cash outflow. For example, a government grant that is intended to reimburse an entity for qualifying operating expenses would be presented in the statement of cash flows as an operating activity if the grant was received after the operating expenses were incurred.
  • When an entity receives the government grant before incurring the related capital or operating expenses, it should present the receipt of the government grant as a financing cash inflow in the statement of cash flows.
  • Lease payments made to repay a finance lease liability should be classified as follows: (1) the principal portion of the payments as cash outflows from financing activities and (2) the interest portion of the payments as cash outflows from operating activities.
  • Cash flows related to the purchases and sales of businesses; property, plant, and equipment; and other productive assets are presented as investing activities in the statement of cash flows. In a business combination, all cash paid to purchase the business is presented as a single line item in the statement of cash flows, net of any cash acquired.
  • Acquisition-related costs such as advisory, legal, accounting, valuation, and professional and consulting fees in a business combination should be reflected as operating cash outflows in the statement of cash flows.
  • The effects of exchange rate changes on cash should be shown as a separate line item in the statement of cash flows as part of the reconciliation of beginning and ending cash balances.