Lease payments waived by lessor - NZ IFRS 9 derecognition or NZ IFRS 16 lease modification?
Lease payments waived by lessor - NZ IFRS 9 derecognition or NZ IFRS 16 lease modification?
For Tier 1 and Tier 2 for profit entities, NZ IFRS 9 Financial Instruments must be applied to all financial instruments. However, there are some exceptions - one of them is for rights and obligations under leases accounted for under NZ IFRS 16 Leases. Despite this exception, lessees must apply the derecognition requirements for liabilities contained in NZ IFRS 9, paragraphs 3.3.1 and 3.3.3.
| ‘An entity shall remove a financial liability (or a part of a financial liability) from its statement of financial position when, and only when, it is extinguished - i.e. when the obligation specified in the contract is discharged or cancelled or expires.’ NZ IFRS 9, paragraph 3.3.1 ‘The difference between the carrying amount of a financial liability (or part of a financial liability) extinguished or transferred to another party and the consideration paid, including any non-cash assets transferred or liabilities assumed, shall be recognised in profit or loss.’ NZ IFRS 9, paragraph 3.3.3 |
Ordinarily, a lessee making lease payments to settle its lease liabilities would, therefore, simply account for the derecognition of these liabilities when lease payments are made to the lessor, and no further journal entries would be required.
|
However, what if the lessor waives some or all of the lease payments due by a lessee? Questions arise about the interaction of the following requirements in NZ IFRS Accounting Standards:
|
This was not addressed as part of the 2024 annual improvements to NZ IFRS Accounting Standards because clarifying the interaction between NZ IFRS 9 and NZ IFRS 16 is beyond the scope of an annual improvement. When lessors waive lease payments for a lessee, it is therefore up to the lessee to determine whether to apply NZ IFRS 9 or 16 and consistently apply that accounting policy choice.
The following examples demonstrate the challenges of deciding which standard trumps.
Fact pattern
Entity A entered into a lease from Entity B for retail space in a shopping centre on 1 January 20X1.
Entity A’s year-end is 31 December.
Entity A is required to make lease payments of $100 per month for five years.
Lease payments are due on the first of the month.
Therefore, as at 31 December 20X1, the remaining lease liability is $4,800 ($100 per month X 4 years X 12 months).
Each of the following scenarios modifies this base fact pattern and is mutually exclusive of one another. For simplicity, discounting has been ignored.
| Issue: Should Entity A account for the changes to the lease contract in each of the above scenarios as:
|
Scenario 1
The shopping centre experienced significant maintenance issues during 20X1.
Therefore, on 1 December 20X1, Entity B agrees to irrevocably waive the $100 payment otherwise due on 1 December 20X1.
The waiver is not required by the contract or applicable law or regulation. No other terms in the lease change (e.g. the future lease payments, the lease term, etc.).
Analysis
The change in consideration meets the definition of a ‘lease modification’ in NZ IFRS 16.
|
‘A change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease (for example, adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term).’
Definition of ‘lease modification’ in NZ IFRS 16, Appendix A (emphasis added) |
NZ IFRS 16.36(c) requires the lease liability to be remeasured for lease modifications, with the effect reflected by adjusting the ROU asset (NZ IFRS 16.46(b)). The journal entry applying NZ IFRS 16 would be:
Dr Lease liability $100
Cr ROU asset $100
However, the change in consideration (with no other changes to the contractual terms) is also a partial extinguishment of a liability (NZ IFRS 9, paragraph 3.3.1), with the effect of the partial derecognition recognised in profit or loss (NZ IFRS 9, paragraph 3.3.3). The journal entry when applying NZ IFRS 9 would be:
Dr Lease liability $100
Cr Profit or loss $100
Given the lack of clarity as to which standard takes preference, entities must select an accounting policy and apply it consistently in accordance with NZ IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors.
Scenario 2
On 1 December 20X1, Entity B agrees to irrevocably waive the $100 payment otherwise due on 1 December 20X1.
At the same time, Entity B also irrevocably waives the $100 payment due on 1 January 20X2 – a lease payment that is not presently due as at 1 December 20X1 (i.e. a ‘future lease payment’).
Analysis
The same analysis applies as set out in Scenario 1 and entities must make an accounting policy choice.
The only difference between Scenarios 1 and 2 is whether all payments being modified are presently due. This should not affect the analysis because the payments are all recognised in the lease liability, regardless of whether they are presently due at the time of the modification.
Scenario 3
On 1 December 20X1, Entity B agrees to irrevocably waive the $100 payment otherwise due on 1 December 20X1.
However, at the same time, Entity A and B agree to extend the lease term by six more months for the same monthly payments of $100 per month.
Analysis
In scenarios 1 and 2, only the consideration was modified. In this scenario, both the consideration and the scope (lease term) have changed.
| ‘A change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease (for example, adding or terminating the right to use one or more underlying assets, or extending or shortening the contractual lease term).’ Definition of ‘lease modification’ in NZ IFRS 16, Appendix A (emphasis added) |
It is not appropriate to reflect the change in the lease liability as a gain in profit or loss (the NZ IFRS 9 approach) because the change in consideration and the scope of the lease are inseparable and must be accounted for as a lease modification. The journal entry would be:
Dr ROU asset $500
Cr Lease liability $500
Need assistance?
BDO offers comprehensive support for your lease accounting needs. Our cloud-based system, BDO Lead simplifies the complexities of implementing NZ IFRS 16. We also provide outsourced Managed Lease Services, handling your lease accounting using BDO Lead.
For assistance, please contact our Financial Reporting Advisory team for help.
For more on the above, please contact your local BDO representative.
This article has been based on an article that originally appeared on BDO Australia, read the original article here.