IFRS 9 Financial Instruments and IFRS 16 Leases — Lessor Forgiveness of Lease Payments (Agenda Paper 4)

Background

In its March 2022 meeting, the Committee discussed 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. The Committee members generally agreed with the conclusion and the staff recommendation to publish a tentative agenda decision for the lessor's accounting on the fact pattern submitted. For the lessee accounting on the forgiven lease payments, the Committee decided to propose a standard-setting project (annual improvement) given the possible alternative interpretations of the principles and requirements in IFRS 16.

23 comment letters were received. 11 respondents agreed with the analysis of the Committee but some requested clarification on some aspects of the conclusion. 11 respondents disagreed with the Committee’s analysis and conclusion. 1 respondent did not express views but requested clarification about application of the expected credit losses (ECL) requirements.

Staff analysis

Most respondents commented on the application of the ECL model in IFRS 9 to the operating lease receivable. A few of them said that a lessor should not recognise an ECL allowance when the reason for granting a rent concession is not credit-related. Some of them said that the Committee did not consider default events in reaching its conclusion and requested the clarification of linkage between “expectations of forgiving lease payments” with “losses that result from default events” in Appendix A of IFRS 9. The staff explained that IFRS 9 requires entities to reflect an unbiased and probability-weighted amount determined by evaluating a range of possible outcomes when measuring ECL and therefore, the lessor is not limited to considering only cash shortfalls resulting from a default or possible default event or related to rent concessions being contemplated because of the lessee’s credit situation or financial difficulties. Also, they considered that the ultimate objective of the net carrying amount of the operating lease receivables is to reflect the cash flows the entity expects to receive, regardless of the reason for the expected cash shortfalls.

Some respondents commented that IFRS 9 does not require an entity to anticipate future cash flows of modification (i.e. future forgiveness of the rental) in measuring ECL. The staff said that instead of anticipating future changes to the contractual terms of the lease contract, the lessor is factoring in its expectations of collecting—or not collecting—lease payments from the lessee in applying the ECL model. Moreover, a few respondents said the agenda decision should better reflect the assessment and measurement of ECL at different points of time. The staff agreed that the lessor should remeasure ECL at the derecognition date of the operating lease receivables as required by IFRS 9 and agenda decision will be amended to clarify this.

After all, the staff continued to agree with the conclusion that the lessor measures ECL on the operating lease receivables in a way that reflects an unbiased and probability weighted amount determined by evaluating a range of possible outcomes, including consideration of the expected forgiveness of lease payments.

Some respondents said the conclusion of not adjusting operating lease income if it modifies a lease contract to forgive specified lease payments that have been recognised as receivables is not consistent with the core requirement in IFRS 16:81 related to recognition of lease income. The staff said that once a lessor recognises an operating lease receivable, the receivable is clearly subject to the derecognition requirements in IFRS 9. If there are other changes to a lease contract beyond forgiveness of lease payments, the lessor may conclude that the derecognition requirements in IFRS 9 are not met but it is not the case in the fact pattern submitted where the forgiveness is the only change and results in the lessee being legally released from making separately identified lease payments. Also, the staff did not think the conclusion is not consistent with the requirement in IFRS 16:81 because only those related to the past have been derecognised while those related to the future are accounted for as lease modification.

A few respondents disagreed with the Committee’s observation that lease payments due from the lessee that the lessor has recognised as an operating lease receivable are not accrued lease payments. The staff explained that IFRS 16:87 refers to ‘accrued lease payments’, which arises from the application of IFRS 16:81 and it represents any difference between lease income recognised and the operating lease receivable while IFRS 9:2.1(b)(i) refers to “operating lease receivables” and it represents the lessor’s contractual right to receive lease payments. In view of the two paragraphs using different phrases, the operating lease receivable recognised is not accrued lease payments.

Some other respondents said forgiveness of lease payments meets the definition of lease incentives. However, the staff continued to hold the view that it does not meet the definition of lease incentives because it is neither a payment made by the lessor to the lessee nor a reimbursement or assumption by the lessor of costs of the lessee. The forgiveness relates to the past; it does not relate to the future—and it does not reduce future operating lease income over the lease term, as would be the case for a rent-free period.

Moreover, some respondents are uncomfortable with the publication of the agenda decision because they are concerned that it will be applied to other fact patterns and it may create potential for structuring opportunities. They requested consideration through the post-implementation review of IFRS 16 or a standard-setting project instead. However, the staff were of the view that all changes to a lease contract negotiated between a lessor and a lessee need to be considered together. The lessor needs to consider holistically all the changes to determine whether its rights to the cash flows from operating lease receivables expire so as to result in derecognition. The staff continued to hold the view that the principles and requirements in IFRS Accounting Standards provide an adequate basis for the lessor’s accounting and to finalise the agenda decision.  

Staff recommendation

The staff recommended finalising the agenda decision with some suggested changes.

Committee discussion

Most of the Committee members agreed with the staff analysis of the comment letters and considered the outcome of the agenda decision to be sensible but they had a lively and extensive discussion on various aspects of the agenda decision.

One Committee member said there are two elements of the rent forgiven: The first one is the actual lease receivables invoiced for the performance completed and contractually due. This part is the financial asset applying IFRS 9 and is subject to the derecognition criteria in IFRS 9. The second part is the amount not yet performed and not derecognised but going through the lease modification applying IFRS 16. The staff echoed this by stating that the modification requirements in IFRS 16 apply to prepaid and accrued lease payments but not to “receivables” which are financial instruments. The Committee member continued to comment that when discussing the ECL implication, instead of considering what the lessor is going to forgive, the lessor considers the macro-economic environment which may indicate the forgiveness of rental amounts due. It would be more appropriate to apply the requirement in IFRS 9 so that forward-looking information is considered. However, another Committee member was not comfortable stating this because it is not in the fact pattern.

A few Committee members said they were not persuaded that all the receivables must be related to past performance because receivables could be recognised in advance of completion of performance. Unlike IFRS 15, which requires the recognition of income taking into account collectability, there was no requirement in IFRS 16 for this. One Committee member followed on by commenting that there can be two situations giving rise to receivables. One for service already performed and invoiced while another is for invoicing a prepayment. She said that the receivables which are subject to forward-looking consideration applying the ECL model is the part with income recognised. Some Committee members suggested adding paragraph AG9 of IAS 32 to help distinguish what is a financial asset because it mentions a lessor does not regard an operating lease as a financial instrument, except as regards individual payments currently due and payable by the lessee. A number of Committee member questioned how to allocate between receivables and accrued payments in a scenario where the lessor could bill the lessee in advance. One Committee member suggested that for the portion related to future lease payment, it would be offset by the deferred rental recognised as a liability on the balance sheet and no ECL would arise from that portion. The staff responded that the agenda decision does not intend to comment on those receivables related to rental not yet performed. She emphasised that IFRS 9 requires measuring ECL based on reasonable and supportable information. Therefore, the information about the uncollectibility of the cash flow due to rent concession could not be ignored.  

Some Committee members said they understood the rationale for the conclusion in the agenda decision that when the lessor is under negotiation for the rent concession, the lessor could be able to incorporate the grant of concession as one of the scenarios applying the probability-weighted approach for ECL. On the other hand, another Committee member questioned how such a rent concession could be considered when applying the PD x LGD x EAD (probability of default x loss given default x exposure at default) model if such rent concession is not a result of the creditability of the lessee and does not affect the PD of the lessee. The staff said the principle of ECL is to estimate the cash flows that an entity expected to receive. If the model could not capture this, it would have to be calibrated.

Committee decision

The Committee decided, by a vote of 11 out of 14, to finalise the agenda decision with suggested amendments to the text.