More examples on accounting for COVID-19-related rent concessions by lessees

In June 2020 Accounting News, we demonstrated how simple COVID-19 related rent concessions such as rent waivers and deferrals are accounted for by a lessee that qualifies and elects to use the practical expedient included in the amendments to IFRS 16 Leases (AASB 2020-4 Amendments to Australian Accounting Standards – Covid-19-Related Rent Concessions).

This month we highlight two additional, more complex, examples where lessees qualify and elect to use the practical expedient to account for COVID-19-related rent concessions. 

Example 1 – Deferral of rental payments for six months and lease term extended by six months

A common scenario expected to occur in practice is a rent concession where lease payments are deferred during the COVID-19 period, but paid to the lessor during an extended lease term. 

Fact pattern

Tourism Co is a tourism operator and entered into a three-year lease for office premises on 1 January 2019. Lease payments are $100 per month paid in arrears. Tourism Co’s incremental borrowing rate is 5% or 0.42% per month.

Tourism Co’s business experienced a significant downturn towards the end of March 2020 when the Australian government imposed a 'Do not travel' ban on all incoming tourism from overseas.

Tourism Co meets the criteria and wishes to apply the practical expedient in accounting for this rent concession in its 30 June 2020 financial statements. The present value of the future remaining lease payments on 1 April 2020, based on the original terms of the lease, is $2,007.

Step one: Recalculate lease liability on 1 April 2020

The benefit of the concession is accounted for when it is agreed between the lessee and lessor. The lease liability is therefore remeasured on 1 April 2020 (net present value is $1,957). The amortisation table for the lease liability based on the revised lease terms (rounded to the nearest dollar) on 1 April 2020 is as follows:

Step two: Recognise difference in profit or loss

The difference between the carrying amount of the original lease liability on 1 April 2020, and the revised lease liability (after taking into account revised lease payments from the concession) is recognised in profit or loss.

Tourism Co therefore recognises the following journal entry on 1 April 2020:

Dr  Lease liability                                    $50
Cr  Profit or loss                                                 $50

Example 2 – Deferral of rental payments for six months – recouped over remainder of lease with additional interest on deferred payments to compensate for time value of money

All the following conditions must be met in order for lessees to apply the practical expedient when accounting for COVID-19-related rent concessions:

Straight deferrals of lease payments, to be repaid by the lessee at a later date, with no changes to the amount of the deferred lease payments would clearly meet criterion (a) above. However, the question arises:

The IASB’s view, when setting the practical expedient, was that ‘The Board was of the view that a rent concession that increases total payments for the lease should not be considered a direct consequence of the covid-19 pandemic, except to the extent the increase reflects only the time value of money.’. Refer to AASB 2020-4, Basis for Conclusions, paragraph BC205D(a).

From this we can conclude that the practical expedient can still be used if the total payments for the lease increases, but only to the extent that the increase reflects the time value of money.

The example below illustrates the accounting for this type of scenario.

Fact pattern

Tourism Co is a tourism operator and entered into a three-year lease for office premises on 1 January 2019. Lease payments are $1,000 per month paid in arrears. Tourism Co’s incremental borrowing rate is 5% or 0.42% per month.

Tourism Co’s business experienced a significant downturn towards the end of March 2020 when the Australian Government imposed a ‘Do not travel’ ban on all incoming tourism from overseas.

Tourism Co therefore meets the criteria and wishes to apply the practical expedient in accounting for this rent concession in its 30 June 2020 financial statements.

The present value of the future remaining lease payments on 1 April 2020, based on the original terms of the lease, is $20,067.

Step one: Recalculate lease liability on 1 April 2020

The benefit of the concession is accounted for when it is agreed between the lessee and lessor. The lease liability is therefore remeasured on 1 April 2020, taking into account the additional $420 per month lease payments due from October 2021 onwards (net present value is $20,099).

The amortisation table for the lease liability based on the revised lease terms (rounded to the nearest dollar) on 1 April 2020 is as follows:

Step two: Recognise difference in profit or loss

The difference between the carrying amount of the original lease liability on 1 April 2020, and the revised lease liability (after taking into account revised lease payments from the concession) is recognised in profit or loss.

Tourism Co therefore recognises the following journal entry on 1 April 2020:

Dr  Profit or loss                                     $31
Cr  Lease liability                                                $31