Rent concessions: Lessors and lessees

Date recorded:

IFRS 9 Financial Instruments and IFRS 16 Leases—Rent Concessions: Lessors and Lessees (Agenda Paper 4)

Background

The Committee received a submission about the application of IFRS 9 and IFRS 16 by both a lessor and a lessee in accounting for a particular rent concession. In the fact pattern described, the lease term of the lease is three years and a rent concession (for month 10 to 14) is agreed by a lessor and a lessee on the date the rent of concession (end of month 12). For the lessor, the rent concession changes the lease contract classified as an operating lease. The lessor legally releases the lessee from its obligation to make specifically identified lease payments while making no other changes to the lease contract. Before the date of granting the rent concession, the lessor recognised an operating lease receivable (for month 10-12) for which the payments were subsequently forgiven. The submitter asks: (a) how the lessor applies the expected credit loss (ECL) model in IFRS 9 to the operating lease receivable when it expects to forgive payments due from the lessee under the lease contract before the rent concession is granted; (b) whether the lessor applies the derecognition requirements in IFRS 9 or the lease modification requirements in IFRS 16 in accounting for the rent concession; and (c) whether the lessee applies the derecognition requirements in IFRS 9 or the lease modification requirements in IFRS 16 in accounting for the rent concession.

Staff analysis

IFRS 9 requires a lessor to apply the ECL model to an operating lease receivable from the date on which it recognises the receivable. Therefore, in the period before the rent concession is granted, the lessor measures any ECL as the difference between the contractual cash flows and the cash flows that the entity expects to receive through the expected life of the lease receivable taking into account its expectations of forgiving lease payments recognised as part of that receivable. In the submission, it is mentioned that some hold the view that the lessor could ignore expected forgiveness of past lease payments on the grounds that the lessor applies the lease modification requirements in IFRS 16. The staff did not agree with this because the lessor has recognised the operating lease receivable before granting the rent concession and is required to apply impairment requirements in IFRS 9 from the date on which the receivable is recognised and the expected forgiving of lease payments cannot be ignored.

Regarding the derecognition of the operating lease receivables, the rent concession results in the lessor legally releasing the lessee from its obligation to make specifically identified lease payments. Accordingly, on granting the rent concession, the lessor would conclude that IFRS 9:3.2.3(a) is met given its contractual rights to the cash flows from the operating lease receivable expire. The lessor would therefore derecognise the operating lease receivable for months 10-12. Moreover, the rent concession in the submitted fact pattern meets the definition of a lease modification in IFRS 16 and therefore IFRS 16:87 applies to treat the modified lease as a new lease from the date of granting the rent concession. The staff emphasised that those forgiven lease payments are not accrued lease payments on the date of the rent concession. The lessor recognises as income the lease payments to be made by the lessee over the term (in month 15-36 of the lease) on a straight-line basis from the date of granting the rent concession (end of month 12). All in all, the lessor applies the requirements in both IFRS 9 and IFRS 16 to different aspects of the rent concession. The staff disagreed with the alternative view that the lessor could apply the lease modification requirements in IFRS 16 to forgiven lease payments recognised as an operating lease receivable because they considered that the derecognition requirements in IFRS 9 in accounting for the legal release of the lessee from its obligation to make specifically identified lease payments cannot be ignored.

In the submitted fact pattern, the rent concession results in the lessee being legally released from its obligation to make specifically identified lease payments. Therefore, a lessee should extinguish the part of the lease liability (for months 10-14) applying IFRS 9:3.3.1 and recognise the effect in profit or loss. Similarly, the rent concession meets the definition of lease modification for the lessee. The lessee therefore first applies IFRS 16:44 to conclude the lease modification is not a separate lease. Then it applies IFRS 16:46(b) to account for the remeasurement of the lease liability using a revised discount rate and make a corresponding adjustment to the right-of-use asset in the scenario where the scope of the lease is not decreased. There is an alternative view and the staff acknowledge the possible interpretation that the lessee can apply the lease modification requirements in IFRS 16 instead of the derecognition criteria in IFRS 9 to the forgiven lease payments. This would result in the decrease of all of the carrying amount of the lease liability being recognised as a decrease in the carrying amount of the right-of-use asset. The staff considered that there is more than one way for the lessee to read the principles and requirements in IFRS Accounting Standards to account for the rent concession and recommended adding a standard-setting project to exclude from the scope of IFRS 16 changes to a lease contract that results only in the extinguishment of the lessee's lease liability.

Staff recommendation

The staff concluded that the principles and requirements in IFRS Accounting Standards provide an adequate basis for a lessor to determine how to apply the ECL model in IFRS 9 to an operating lease receivable and account for the rent concession described in the request. Consequently, the staff recommended not adding a standard-setting project to the work plan but publishing a tentative agenda decision for lessor's accounting. At the same time, a standard-setting projected is recommended for the lessee's accounting for the forgiven lease payments.

Committee discussion

The Committee members generally agreed with the lessor's accounting for derecognition of the receivables under IFRS 9 and the rent modification requirement under IFRS 16. However, a significant number of members had concerns on the analysis of the application of the ECL model in the staff paper. For the lessee's accounting, all of them agreed that standard-setting is required to clarify the interaction between the IFRS 9 derecognition and IFRS 16 modification requirements.

Some Committee members thought it good that the proposed tentative agenda decision clearly laid out the thought process for the sequence of the application of IFRS 9 and IFRS 16 to the lessor's accounting regarding the forgiveness of the rent. They agreed that when the lessor legally extinguished the receivables that it is entitled to, the derecognition requirements in IFRS 9 are applied to the receivables. After that, the modification requirements in IFRS 16 apply to the future lease payments. One Committee member was of the view that the same treatment should apply more broadly to the lessor's accounting when there is partial forgiveness.

However, there were a number of Committee members who disagreed that the forgiven rental payments  should not be considered as a rent concession. They cited IFRS 16:BC240 which states that the forgiven lease payment could be considered as rent incentive under new leases for the lessor. The staff responded that unlike prepaid and accrued rental, which is subject to the modification requirements in IFRS 16, the derecognition of lease receivables is within the scope of IFRS 9. Given that the receivables have been distinguished legally, they could not be considered as incentives for the new leases.

There were different views on whether the expected forgiveness of rent should be taken into consideration in the assessment of ECL of the receivables. Some Committee members considered that the forgiveness of rent is clearly indicating that the lessee is in financial distress and should therefore be taken into account in the ECL model. However, some Committee members were of the view that if the forgiveness of rent is due to reasons other than the credit risk (e.g. a commercial reason), it may not be required to be taken into account in the impairment assessment. One Committee member said that a real credit event versus the substance of the lease forgiveness (affecting the revenue of the lessor) should be distinguished. The staff responded that if the lessor is negotiating with the lessee about the rent waiver, the expected non-payment would be one of the scenarios to be taken into consideration applying the probability-weighted approach of the ECL model.

Some Committee members suggested specifying that the expected forgiveness of the rental is due to the credit risk of the lessee. This would help to reach the conclusion that it be taken into account in the ECL measurement. The departing Chair said it was intentional not to specify this because ECL is a mathematic calculation and it should capture the expected amount that the lessor does not expect to collect on the gross amount. This amount is only derecognised when it is extinguished legally.

Regarding the lessee accounting, a number of Committee members considered that it is clear that the derecognition criteria in IFRS 9:3.3.1 should be applied first to the lease liability which is a financial liability. The next step would be to apply the modification requirements in IFRS 16 by applying a revised discount rate to the remaining lease payments on the date of modification. However, some Committee members questioned whether the discount rate needs to be revised in view of the fact that there is no change in the cash flows after the derecognition of the lease liability.

The remainder of the Committee members generally agreed that there are alternative views in interpreting the principle of the existing Standard that either IFRS 9 or IFRS 16 could be applied to the forgiven rent. The staff further supplemented that the accounting of the lessee is different from that of lessor in the way that the lessee obtained an asset and a single liability for all of the lease payments. When IFRS 16 was drafted, it was explicitly intended that only the derecognition requirement in IFRS 9:3.3.1 would apply. However, the modification would be accounted for applying IFRS 16 instead of applying IFRS 9:3.3.2. Therefore, the staff recommended an annual improvement to IFRS 16 to clarify that the modification requirements of the lessee should be applied to all modifications except to those which are a "solely legal extinguishment" of the lease liability.

Committee decision

The Committee decided, by a vote of 9 out of 13, not to add the matter to the standard-setting agenda and instead to publish a tentative agenda decision for the lessor's accounting on the fact pattern submitted. In addition, 9 out of 13 Committee members agreed that there are alternative approaches for the lessee accounting. The Committee decided by a vote of 12 out of 13 to propose a standard-setting project with respect to the lessee's accounting for the rent concession as described in the submission.

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