The European Securities Markets Authority (ESMA) has today published a Public Statement calling for co-ordination of supervisory action on accounting for lease modifications arising as a direct consequence of the COVID-19 pandemic.
IFRS 16 Leases contains requirements that specify the financial reporting treatment to be applied for changes in lease payments, including rent concessions. In May 2020, following an accelerated and well supported due process, the International Accounting Standards Board (IASB) published an amendment to IFRS 16 Covid-19-Related Rent Concessions – Amendment to IFRS 16 (the Amendment), applicable for annual reporting periods beginning on or after 1 June 2020 or earlier. The Amendment provides a practical relief from IFRS 16’s requirements to lessees who were granted COVID-19-related rent concessions. However, the Amendment is not yet adopted pursuant to the EU endorsement procedure.
ESMA acknowledges that the COVID-19 outbreak brings significant challenges for entities applying the existing IFRS 16 requirements to potentially large volumes of COVID-19-related rent concessions. In particular, ESMA understands the practical difficulties of assessing whether COVID-19-related rent concessions are lease modifications and, for those that are, applying the financial reporting requirements, and is aware of the risk of diversity in practice which may result.
Therefore, ESMA, in co-ordination with EU national accounting enforcers, expects EU national accounting enforcers (including IAASA) not to prioritise supervisory actions in relation to the application of the requirements for lease modifications contained in IFRS 16 as currently endorsed by the EU to COVID-19-related rent concessions that would otherwise fall within the scope of the Amendment, provided that entities apply to those transactions the financial reporting treatment set out in the Amendment.
Where an entity applies the Amendment, ESMA and EU national accounting enforcers expect the issuer to disclose compliance with the Amendment as issued by the IASB in the notes to the financial statements.
The ESMA Public Statement may be accessed here.
A summary of the financial reporting treatment of leases concessions is set out below
Summary of financial reporting treatment of leases concessions
The COVID-19 pandemic has resulted in certain lessors providing relief to lessees by deferring or relieving them of amounts that would otherwise be payable. In some cases, this is through mutual agreement between the parties following negotiations; however, it may also arise as a consequence of a government encouraging or requiring that the relief be provided.
When there is a change in lease payments, the financial reporting treatment to be applied depends on whether that change meets the definition of a “lease modification”.
IFRS 16 Leases 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 (for example, adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term).”
In May 2020, the IASB issued the Amendment which is applicable for annual reporting periods beginning on or after 1 June 2020 or earlier.
However, for entities applying IFRS as endorsed by the EU, it should be noted that the Amendment was not endorsed by the EU at 30 June 2020 – a half-yearly reporting date for many issuers falling within IAASA’s financial reporting review remit. It is expected that the EU endorsement process could be completed before the end of Q3 2020.
In normal circumstances prior to the Amendment, IFRS 16 required that, when a lease contract is modified, the lessee make an adjustment to the carrying amount of the right-of-use asset and generally recognise the effects of the rent concession over the useful life of the right-of-use asset.
In summary, should a lessee apply the practical expedient in the Amendment, it would account for those rent concessions as if they were not lease modifications so that, for example, the amount of rent forgiven on or before 30 June 2021 is taken to income the same year that the concession is granted, instead of being allocated over the duration of the contract as would be the case were the practical expedient in the Amendment not allowed.
Under the Amendment, IFRS 16 is amended so that a lessee may elect not to assess whether a rent concession that meets certain specified conditions (see below) 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 specified conditions of a rent concession eligible to be accounted for under the Amendment are:
- the rent concession occurs as a direct consequence of the COVID-19 pandemic;
- 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; and
- there is no substantive change to other terms and conditions of the lease.
The Amendment makes no changes to lessor accounting.