Under IFRS 16, lessees are required to recognise lease assets and lease liabilities on their balance sheets, which represents the right to use the leased asset and the obligation to make lease payments, respectively. This changed the accounting treatment, particularly for operating leases.
The standard is applicable to all large-for profit entities and aims to improve transparency and comparability in financial reporting by requiring these entities to recognise the full extent of their lease obligations on their balance sheets.
A modification is a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions. Some possible modifications in the current environment are as follows:
1. Change in lease term
The lease term is defined as the non-cancellable period for which a lessee has the right to use an underlying asset (including any periods covered by a lessor’s termination option), plus:
- periods covered by a lessee’s extension option if extension is reasonably certain; and
- periods covered by a lessee’s termination option if the lessee is reasonably certain not to terminate.
Recent weather events may have caused many lease terms to change with motor vehicles being written off and flood/cyclone damage to property causing businesses to relocate.
Also, with most businesses moving to flexible working from home policies, square footage per employee may be decreasing, calling for downsizing and decreasing the term in your current lease, or exercising a renewal option (increasing the term) if your current premise is now sufficient for the growth of the business.
When remeasuring the lease term, it’s important to remember that you must use a discount rate that reflects the interest rate implicit in the lease or your incremental borrowing rate (IBR), if the implicit rate cannot be readily determined. The OCR was 1.75% on 1 January 2019 when NZIFRS 16 became effective, it’s now at 4.75%. So, it’s appropriate to continue to review the IBR for new leases as well as existing leases with a change in lease term.
2. Change in lease payments
Market rent reviews may have seen lease payment increases (or in some cases, decreases); this will need to be factored into the lease calculation on a prospective basis.
The notable exception is the practical expedient where a lessee, under certain circumstances, may elect not to assess whether a rent concession received because of the covid-19 pandemic is a lease modification.
However, it has now been more than three years since the World Health Organistation declared a global pandemic due to covid-19. Therefore, it is unlikely this practical expedient is still applicable.
What about public benefit entities?
Currently, public benefit entities (PBEs) do not need to recognise the right to use the leased asset and the obligation to make lease payments. However, change is on the horizon.
Consultation on the International Public Sector Accounting Standards (IPSAS) Board’s exposure drafts on leases IPSAS 43 has just concluded. The feedback received indicated broad support for the proposals to align lease accounting with IFRS 16. More information and the draft of IPSAS 43 can be found here. The current proposal does not include concessionary leases, but a separate consultation is expected for these in due course.
Currently, the effective date is expected to be 1 January 2027, with early application permitted to allow PBEs sufficient time to prepare for the application of the standard. The current draft does not include fair value measurement requirements for concessionary leases (i.e. leases with below-market terms). It is not intended for IPSAS 43 to become mandatory in New Zealand before the requirements for concessionary leases become available.