IFRS 16: Leases and Covid-19
November 2021 – The new IFRS 16 for leases became applicable in Europe on 1 January 2019. This standard requires lessees to capitalise their lease liabilities on their balance sheet. If a lessee now receives rent relief to overcome the Covid-19 pandemic, this will in principle also have an impact on its accounting. But we are not there yet.
IFRS 16
As of 1 January 2019, there is in principle only one standard in force for the correct accounting of leases, both for the lessor and the lessee. This standard applies in principle to all leases, except for some service concession arrangements or intellectual property licences.
When entering into a contract, it is always necessary to assess whether the contract is or contains a lease. This is the case if the contract 'conveys the right to control the use of an identified asset for a specified period in exchange for consideration'.
In accordance with IFRS 16, the lessee shall measure the lease liability at the inception of the lease at the present value of the outstanding lease payments. The present value of the lease payments shall be calculated either using the interest rate implicit in the lease (if it is possible to determine this rate easily) or using the lessee's incremental borrowing rate.
Modification of the lease
In principle, a lessee should account for any modification of a lease as a separate lease if the modification expands the scope of the lease by adding a right to use one or more underlying assets and the lease consideration increases.
But even if the lease modification is not accounted for as a separate lease, the necessary entries must be made.
In particular, the lessee should recognise the revaluation of the lease liability by :
reducing the carrying amount of the right-of-use asset recognised to reflect the effects of the partial or full termination of the lease, provided that the change represents a reduction in the scope of the lease. The lessee shall recognise in profit or loss any gain or loss arising from the partial or full termination of the lease;
making a corresponding adjustment to the right-of-use asset for all other changes to the lease.
Covid-19 rent relief
A rent relief is most certainly a lease modification. But rent relief due to the Covid-19 pandemic is, in 99% of the cases, temporary: the landlord (lessor) wants to give his lessee the opportunity to overcome this difficult period. After the pandemic, normal conditions will apply again.
While the aim of IFRS 16 is precisely to give a clear picture of the financial impact of a lease on a company's cash flows, adapting the accounting to such a temporary impairment would have precisely the opposite effect.
It was therefore already decided in mid-2020 to allow the lessee to consider a rent reduction as not constituting a change in the lease contract. This was only allowed if the rent concessions were a direct consequence of the Covid-19 pandemic and the following conditions were met
the change in rent paid results in a revision of the consideration of the lease which is substantially the same as, or lower than, the consideration of the lease immediately before the change ;
the rent relief only affects the rents that were originally due on or before 30 June 2021 (for example, a rent concession would meet this condition if it resulted in a reduction in the rents paid for the period up to 30 June 2021 at the latest and an increase in the rents paid for the period after 30 June 2021); and
there is no material change in the other terms of the lease.
Extension for a further year
The European Commission has now decided to extend by one year the tolerance under which certain rent concessions related to the Covid-19 are not considered as modifications of the lease contract.
This extension only applies to rents that were originally due on or before 30 June 2022.
For the rest, the same conditions apply as for last year's tolerance.
Every company is obliged to apply these changes from 1 April 2021. Earlier application is permitted, including in annual accounts that have not been approved for publication by 31 March 2021.
