IFRS 16 assessments and interpretation of leases raise many questions
IFRS 16 is a comprehensive accounting standard that requires a good overview and understanding of how lease contracts should be reflected in the accounts. Read some key questions and answers about IFRS 16 assessments and interpretation of lease agreements.
Which rent should be used as a basis?
In the case of an IFRS 16 assessment, the use of a modified retrospective method can be the rent 1.1.19 which forms the basis for the calculation of the obligation 1.1.19. It is not necessarily the amount stated in the lease or what was paid on the last invoice for 2018. The rent may have to be indexed on 1.1.19. The amount may also include payment for elements other than renting the asset.
What payments are associated with the lease of the asset, and what are non-lease elements?
It must be assessed what is actually payment for renting the asset and what is payment for the transfer of a good or a service. This is not always clear from the agreements or invoices. Some non-rental elements (separate goods and services) may be included in the total payment, such as maintenance.
Payments may also relate to the landlord’s activities and expenses, which are neither rent nor non-rent elements. This may apply to property tax, the landlord’s administration costs and insurance. The total payment in the contract must be distributed between rental and non-rental elements. The lessee can, for each class of assets, choose not to separate out non-lease elements. Only the fixed payments can be included in the lease liability in the balance sheet.
What is variable and fixed rent?
Variable rent, and possibly other variable payments, cannot be included in the calculation of the liability and the asset. Some companies have previously not clearly distinguished between these in reporting the cost or the note on future operational lease obligation according to IAS 17. An example is turnover-based rent which is not part of the lease obligation, while guaranteed minimum rent will be.
Does IFRS 16 include assessments of a lease agreement an identified asset?
A lease embedded in a service agreement must have been assessed according to IFRIC 4 and separated as a separate element. Since this has not had a major impact on the presentation in the accounts, some companies have not carried out a thorough survey and assessment of this. This may mean that there are more lease agreements than previously reported. Alternatively, an agreement may apply to the rental of less than approximately the entire capacity of an asset and will then not be covered.
How long is the rental period?
The length of the lease period has great significance for the liability and the asset in the balance sheet. The IAS 17 note on future operating lease payments has focused on future minimum rent under non-cancellable operating leases, which is not the same lease period as defined in IFRS 16. –
Options for extension or a termination right are of great importance in determining the rental period. The companies may find it difficult to operationalise, document and establish internal control routines for this. It can be challenging to get an overview of financial incentives to extend or not to terminate an agreement. Audit committees and management should be involved in these assessments. Lease contracts with mutual termination also give rise to difficult assessments.
An example is agreements that run until terminated by one of the parties, or agreements that are automatically extended if they are not terminated by one of the parties. In an IFRS 16 assessment, it is mentioned that a lease is not enforceable when both the tenant and the landlord have the right to terminate the lease without the other party’s permission and with only an “insignificant penalty”. There has been a development where it now seems that insignificant fines should be interpreted broadly, to include more than pure termination payments. This makes it challenging to assess whether it is an insignificant fine, and assessments must in some cases be made again when the interpretation of an insignificant fine is changed.