Lease restoration provisions: Post-business combination accounting

When a Tier 1 or Tier 2 for profit business acquires another as part of a business combination, the acquirer must determine the appropriate accounting for the acquiree’s leases, including its lease restoration provisions. The acquiree continues to recognise its leases as usual, but the acquirer, in its group financial statements, has to make various adjustments in the group’s consolidated financial statements.

At the acquisition date, the acquirer in a business combination must measure the acquiree’s:
  • Lease liabilities - at the present value of the remaining lease payments (as defined in NZ IFRS 16 Leases) as if the acquired leases were new leases at the acquisition date, and
  • Right-of-use (ROU) assets - at the same amount as the lease liability, adjusted to reflect favourable or unfavourable terms of the lease when compared with market terms.

The acquirer then recognises, at fair value, the acquiree’s lease restoration obligations (separately from the lease liability) as a provision under NZ IAS 37 Provisions, Contingent Liabilities and Contingent Assets, with the debit side reflected as either an increase in goodwill, or preferably, as part of (an increase) in the right-of-use asset.

How to account for changes in the acquiree’s restoration provisions?

After the acquisition date, the acquirer will have to update (re-estimate) its measurement of the acquiree’s lease restoration provisions at each reporting date. This may result in an increase or decrease in the carrying amount of these provisions.

If the acquirer chooses to recognise the debit side of an acquiree’s restoration provisions in a business combination as part of goodwill, any subsequent movements in the acquiree’s lease restoration provisions must, therefore, be recognised in profit or loss.

However, if the acquirer recognises the debit as an increase in the ROU asset, subsequent movements in the acquiree’s lease restoration provisions can be accounted for in one of two ways:
  • Method 1 – Changes are recognised in profit or loss on the basis that NZ IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities does not apply, or
  • Method 2 – Changes are recognised in accordance with NZ IFRIC 1, with movements added to or deducted from the cost of ROU assets (assuming the cost model is used for ROU assets).

‘This Interpretation applies to changes in the measurement of any existing decommissioning, restoration or similar liability that is both:
a. recognised as part of the cost of an item of property, plant and equipment in accordance with NZ IAS 16 or as part of the cost of a right-of-use asset in accordance with NZ IFRS 16; and
b. recognised as a liability in accordance with NZ IAS 37.

For example, a decommissioning, restoration or similar liability may exist for decommissioning a plant, rehabilitating environmental damage in extractive industries, or removing equipment.’

NZ IFRIC 1, paragraph 2 (emphasis added)

Method 1 – Recognise movements in profit or loss

Method 1 assumes that NZ IFRIC 1 cannot apply to movements in a lessee’s lease restoration provisions because the related ROU asset was not recognised in accordance with NZ IFRS 16 (refer to extract (a) above). Rather, it was recognised in accordance with paragraph 28B of NZ IFRS 3, whereby the acquiree’s ROU asset equals its lease liability at the business combination acquisition date.

Therefore, movements in the lease restoration provision subsequent to the business combination acquisition date are recognised in profit or loss.

Method 2 – Recognise movements as an adjustment to the cost of the ROU asset

Method 2 assumes that the effect of the restoration provision recognised for the ROU asset in the business combination indirectly affects the cost of the ROU asset recognised. Therefore, both criteria in NZ IFRIC 1, paragraph 2 are met, and any movements in the restoration provision are added to or deducted from the cost of the acquiree’s ROU assets recognised as part of the business combination.

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.