IFRS 16: Amendment Rent Concessions - Ep 6

Transcript

Interviewer Dipthi: Welcome to this episode of the Telco Talks podcast series focusing on topical issues in the telecommunications industry. I’m Dipthi Govind, a technical accounting manager in the PwC South African practice and I will be your host. Our aim is to keep you up to date on key accounting issues in the telecommunications industry.

Joining me on this podcast is Thamesha Chetty, a technical accounting manager specialising in the telecommunications industry in our PwC South African practice.

Welcome Thamesha.

Thamesha: Thanks Dipthi. It’s good to be back joining you on the Telco Talks series.

Dipthi: The current economic environment and the impact that COVID-19 has had, has resulted  in relief measures being implemented, either by counterparties to agreements or in certain cases by government.

We have seen rent concessions whereby governments may impose rental holidays or deferrals or a lessor may voluntarily grant rent concessions as a means to assist a lessee during this challenging economic climate.

This will be the focus of today’s podcast, and particularly the IFRS 16 accounting considerations regarding rent concessions for lessees.

Thamesha, before we get into the accounting detail, would you mind sharing some examples of rent concessions and what we’ve been seeing in practice.

Thamesha: Sure Dipthi. Rent concessions can fit into a few broad categories:

• There can be concessions that arise from pre-existing clauses in lease contracts. For example, some lease contracts may be structured in a way that provides guidance as to what the parties are entitled to in the case where there are events that occur that are outside of their control and what relief may be provided. 
• As you’ve briefly mentioned, rent concessions can arise from actions of the government - in other words governments may require lessors to provide rent concessions to lessees.
• There’s also the forgiveness or waiver of lease payments by the lessor.

A waiver of rental payments would be for example, when during the lockdown period the government announces that stores in malls need to be closed for a three month period. A lessor may waive or forgive the rentals due by the lessee during this period, such that the lessee will not have to make these payments at all during this period, nor at a later date.

• Then there’s also deferral of lease payments by the lessor.

A deferral of lease payments is where the rental due by the lessee will not be forgiven or waived, but will be deferred to a later period or point in time.

Although there are additional forms of rent concessions, in my experience, the more common rent concessions are waivers and deferrals of rental payments as I have just briefly explained.

Dipthi: Thanks Thamesha. It seems that these rent concessions may have a broad impact across various industries, how do you expect this to impact telco entities.

Thamesha: Telco entities may have a range of and numerous lease agreements in place. Many operators lease stores in malls for example and it would need to be considered whether parties to the lease agreements have implemented rent concessions of some form, or if there is a requirement from the government to provide relief to lessees. 

Operators may also lease assets to entities within a group, and could provide relief to their subsidiaries in the form of rent concessions, so this is also something to look out for.

These are just a few examples of where and how this could apply in the telco space, however entities would need to consider their lease agreements in place and whether rent concessions have been offered or provided to them.

Dipthi: Moving onto more of the accounting detail, 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. 

Your explanation of rent concessions sounds very much like these are lease modifications in terms of IFRS 16.

Thamesha: I see why you may automatically think of that Dipthi, as when there is a deferral or waiver of rental payments, this may indicate that the consideration of the lease has changed, and therefore could potentially be regarded as a lease modification. 

However, this is highly dependent on facts and circumstances, and judgement may also need to be exercised in determining the substance of the arrangement and what the appropriate accounting may be. So it could end up that a rent concession is actually not a lease modification.

This is where the IASB has now stepped in to assist, particularly in light of the COVID-19 pandemic.

Dipthi: Oh yes, the IASB has recently issued an amendment to IFRS 16 related to COVID-19-Related Rent Concessions.

Could you perhaps provide a brief overview of this new amendment.

Thamesha: A bit earlier in 2020, around April, the IASB issued educational material and what to consider when lessees and lessors enter into arrangements as a result of COVID 19 regarding rent concessions, however they soon realised that it could be quite complex to perform the IFRS 16 modification assessment and apply the requirements to a potentially large volume of leases – particularly in light of the many other challenges that lessees are currently facing during the pandemic. 

As a result, the IASB has provided lessees with relief in the form of an optional expedient from assessing whether a rent concession related to COVID-19 is a lease modification. 

It is key to note however that this relief is unfortunately not available to lessors, and is only available to lessees. 

Dipthi: Thanks for that Thamesha. Can you expand on when a lessee is eligible to apply the amendment?

Thamesha: That’s a good question to start off with Dipthi, and the amendment is quite restrictive in terms of in which circumstances it will apply. 

Should the lessee choose to apply the expedient, then  it only applies to rent concessions occurring as a direct consequence of the COVID-19 pandemic, and only if 3 specific criteria are met.

Firstly, the change in lease payments must result in revised consideration for the lease that is substantially the same as, or less than, the consideration for the lease.The amendment refers to “substantially” the same, as there could be instances where the lessor may add interest to the consideration, in the case of a deferral of lease payments for example, which may then increase the lease payments. Where the increase in consideration reflects only the time value of money, the consideration is

substantially the same, and so the rent concession could be in the scope of the practical expedient.

Dipthi: Am I correct then in saying that where the lease payments are increased such that the revised consideration is not substantially the same as the consideration before the change, then this would not be in the scope of the practical expedient?

Thamesha: Yes, that’s spot on Dipthi. 

To move on to the second criteria, the expedient is limited to a time period - any reduction in lease payments affects only payments due on or before 30 June 2021; 

It is important to note that if reductions in lease payments extend beyond 30 June 2021, the rent concession in its entirety would not be within the scope of the practical expedient. It would not be appropriate to apply the practical expedient to the portion of the rent concession that reduces lease payments before 30 June 2021, and then apply IFRS 16,

without the practical expedient, to the portion of the rent concession that reduces lease payments after this date.

If the rent concession reduces lease payments due on or before 30 June 2021, but then there is a related increase in lease payments that extends beyond 30 June 2021, provided the other conditions are met, this could be within the scope of the practical expedient.

It is only the reduction that needs to happen on or before 30 June 2021.

Lastly, there must be no substantive change to other terms and conditions of the lease. No further guidance around the concept of “substantive” has however been provided. Both quantitative and qualitative factors should be considered. 

So if as part of the discussions between the lessor and the lessee, there is a revision to all the lease terms and conditions, then the lessee would most likely not be able to apply the expedient. 

Dipthi: Now that we know when you’re in the scope of the amendment, how does a lessee account for rent concessions if it qualifies and elects to apply the practical expedient?

Thamesha: If lessees apply the practical expedient, then they would account for rent concessions as if they were not lease modifications. In many cases, this will result in accounting for the concession as a negative variable lease payment. So lease payments would be accounted for in the period in which the lease concession occurs, and there would be a partial derecognition of the lease liability and a gain recognised in profit or loss.

Dipthi: Are there any differences in the accounting that one should be aware of depending on what type of rent concession is provided?

Thamesha: Yes, for a forgiveness or waiver of lease payments, lessees will apply IFRS 9 derecognition of financial liabilities thinking. This would result in a partial derecognition of a lease liability and a gain in profit or loss for the present value of the lease payment forgiven.

With regards to deferrals of lease payments, the IASB’s education material explains that the accounting depends on whether the deferral is considered to be proportionate, but did not go into detail of what it means to be proportionate. In our view, proportionate could mean for example,  where lease payments have been deferred for 3 months, and have doubled for the 3 months following that. 

Where it is determined to be proportionate, there is no lease modification, as there is no change in the consideration for the lease to start off with. It should be considered whether there is a time value of money impact in relation to the lease liability.

Basically, one would adjust the lease liability and recognise a gain relating to the present value difference due to the delay in payment.

For any other types of concessions, for example disproportionate payment deferrals, or where terms and conditions have changed substantially, then the modification guidance in IFRS 16 would need to be followed. If there is a lease modification, then the lessee would use the lease payments going forward applying a revised discount rate, and there would be a corresponding adjustment to the lease liability. 

Dipthi: Is there any impact on the right of use asset?

Thamesha: That’s a good question. There is no direct impact on the right of use asset as a result of rent concessions, so a lessee would account for the right of use asset applying the normal principles in IFRS 16. However, the fact that there has been a rent concession granted may be an indicator of impairment, so an entity may need to test the right of use asset for impairment under IAS 36. 

Dipthi: And for our listeners,  we touched on impairment considerations in our last podcast. Thanks for those insights Thamesha. When can listeners expect the amendment to be effective?

Thamesha: The amendment is effective for annual reporting periods beginning on or after 1 June 2020. Earlier application is permitted, including in interim or year end financial statements not yet authorised for issue at 28 May 2020, as the IASB wanted to permit the application of the relief as soon as possible.

Dipthi: A final question before we wrap up, would a lessee be able to apply the practical expedient to all of its leases?

Thamesha: Well  the practical expedient should be applied consistently to leases with similar characteristics and in similar circumstances. For example, it could be applied to all property leases which are leases of the same class, but not to equipment leases to the extent the criteria are not met.

Dipthi: This has been a very interesting and useful session, and I’m sure it's given our listeners a lot to think about and consider. 

Thank you for joining us today Thamesha. 

Thamesha: Thanks Dipthi!