ifrs 16 - masterclass · ―10 years lease of an office floor (f1) ―lease payments are...

IFRS 16 Masterclass

Lessee Modifications and Lease Incentives—October 2019

2© 2019 KPMG Advisory N.V., registered with the trade register in the Netherlands under number 33263682, is a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved.

Introduction

Paul NapPartner

Sam CurwenManager


IFRS 16 business impacts

Systems & Processes― System solution― ERP integration― Future process design

Finance― Transition options― Data collection― Tax― KPIs

Investor relations― External communication― Analyst queries

Other impacts― Management reporting― Management remuneration― Training

Strategy― Lease vs buy― Lease structuring ― Sale and leasebacks

Treasury― Covenants― Credit rating― Discount rates

IFRS 16 accounting

change

Finance― Transition options― Data collection― Tax― KPIs― Impairment & Valuations― Complex accounting


Lease modification

Lease modification Lease reassessment

A lease modification is: ― a change in the scope of a lease, or ― the consideration for a lease,…… that was not part of its original terms and conditions.

Lease reassessments take place when:― there are changes in the lease payments, or ― lease term,……..based on contractual clauses in the original contract.


Modification and reassessment examples

Scenario #1Company A negotiates with its supplier to add the right to use an additional office floor in the same building the company already leases 2 floors.

Scenario #2An event occurs which causes Company B to revise the amount it expects to pay under the residual value guarantee it has provided to the supplier of a crane.

Is this a reassessment or a modification?Q

A This is a modification as the additional office floor was not part of the original lease agreement.


AThis is lease reassessment as this is a change in the estimate of the residual value guarantee Company B expects to pay under the lease.


Modification and reassessment examples

Scenario #1Company C leases an office for 10 years. After one year the company determines it is now reasonably certain to exercise a termination option which is available at year the end of year 3.

Scenario #2During the fourth year of an equipment lease company D agrees with its supplier to extend the lease term for office equipment from 5 to 10 years.


AThis is lease reassessment as this is a change in assessment of the lease term arising from a termination option in the original contract.


AThis is a modification as it increases the scope of the lease by extending the contractual lease term that was not part of the original terms and conditions.


Lease liability – re-measurement

Re-measure liability to reflect reassessment of any changes in:

Unchanged discount rate

― Expected amount payable on the residual value guarantee

― Index or rates― In-substance fixed payments

For each trigger:Which discount rate

Revised discount rate― Lease term― Floating interest rates― Assessment of purchase options


Lease reassessments

Changes in carrying amount of lease liability due to:

Reassessment of lease term, purchase option and residual value guarantee

Variable usage payments

Reassessment of in-substance fixed payments and variable lease payments depending on an

index or rate

Relates to future periods

Relates to current period

Adjust ROU assets (recognise in profit or loss if zero balance) Recognise in profit or loss


Lease modifications – lessee accounting

Is the modification in substance a separate new lease?

Yes

Account for as separate lease

No

No

Is the modification a decrease in scope?

Yes

Modify existing leaseAdjust ROU asset

Modify existing leaseRecognise gain or loss /

adjust ROU asset

Modify the existing lease

1 2 3


Increase in scope – separate leaseScenario A

1

Case― 10 years lease of an office floor (F1)― Lease payments are €1.000.000 p.a.― Incremental borrowing rate is X%

Scenario― End of Year 4, lessee signs an amendment to lease an

additional floor (F2) for an €1.200.000 p.a. for 6 years― Market rent of F2 is €1.200.000― Incremental borrowing rate is Y%

What type of modification is this scenario and how does the accounting work? Q A

This modification increases the scope by adding an additional asset (floor) at a standalone rate. It is accounted for as a separate lease and a new lease liability and ROU asset is recognised.

How is the new lease liability calculated?Q ALease liability is recognised at present value €1.200.000 for remaining 6 years at revised discount rate of Y%.


Increase in scope – modified existing leaseScenario B

Case― 10 year lease of an office floor (F1)― Lease payments are €1.000.000 p.a.― Incremental borrowing rate is X%

Scenario― End of Year 4, lessee signs an amendment to lease an

additional floor (F2) for an €1.000.000 p.a. for 6 years― Market rent of F2 is €1.200.000― Incremental borrowing rate is Y%


This modification increases the scope by adding an additional asset at a rate which is less than the standalone rate.The existing lease is modified by re-measuring the lease liability and making a corresponding adjustment to the ROU asset.

How is the modified lease liability calculated?Q ALease liability is calculated at the present value €2.000.000 for remaining 6 years at revised discount rate of Y%.

2


Increase in the lease termScenario C

Case― 20 year lease of an industrial building, no extension

options― Lease payments are €150.000 per annum― Incremental borrowing rate is 5%

Scenario― End of Year 18 – an extension is agreed for an

additional 10 years― No change in annual lease payment ― Incremental borrowing rate is 3%


This modification does not increase the scope by adding an additional asset. The existing lease is modified.

Immediately prior to the modification:ROU asset €187.000 Lease liability €278.000 The modified lease liability is €1.493.000What is the journal entry to reflect the modification?

Q A

DR ROU asset €1.215.000CR Lease liability €1.215.000Balance sheet values immediately post modification:DR ROU asset €1.402.000CR Lease liability €1.493.000

2


Decrease in scope (1/4)Scenario D

3

Case― 10 year lease for right to use 10.000 m² warehouse

space― Lease payments are €100.000 p.a.― Incremental borrowing rate is 5%

Scenario― Contract modified to lease 7.500 m² for last 4 years― Lease payments are €85.000 ― Incremental borrowing rate is 2%


This modification decreases the scope of the lease. The existing lease is modified and a gain or loss is recognised.

Y0-Y6 10.000 m² warehouse spaceLease payments

€100.000

Y7-Y10 7.500 m² warehouse space Lease

payments €85.000



Decrease the pre-modification ROU asset and lease liabilityRecognise any gain or loss in the P&L

Step 1

Pre-modificationLease liability €355.000ROU asset €309.000

Post step 1 valuesLease liability €266.000ROU asset €232.000

AdjustmentDt Lease liability €89.000Cr ROU asset €77.000Cr P&L (Gain) €12.000

Contract modification reducesthe space leased from 10,000m² to 7.500m² for the final last 4 years i.e. a 25% reduction in space

Reduce lease liability and ROU asset by 25%Lease liability €89.000 (25% * €355.000) ROU asset €77.000 (25% * €309.000)

3

End Y6



Adjust lease liability to reflect re-measurementPost the corresponding adjustment to the ROU asset

Step 2

Post step 1 valuesLease liability €266.000ROU asset €232.000

Post modificationLease liability €324.000ROU asset €290.000

AdjustmentCr Lease liability €58.000Dt ROU asset €58.000

― Lease payments are €85.000 ― Incremental borrowing rate is

2%

Remeasure the lease liability: 4 years of €85.000 discounted at 2%= €324.000Leading to an amount to post of = €58.000

3



Pre-modificationLease liability €355.000ROU asset €309.000

Post modification valuesLease liability €324.000ROU asset €290.000

AdjustmentDt Lease liability €31.000Cr ROU asset €19.000Cr P&L (Gain) €12.000

Y0-Y6 10.000 m² warehouse spaceLease payments

€100.000

Y7-Y10 7.500 m² warehouse space Lease

payments €85.000

3


Effective date of a modification

Effective date of a = Date that both parties agree to the modification lease modification (i.e. date the modified contract is signed)

IFRS 16.45 : Measure the modified lease liability on this date (unless modification is accounted for as separate lease)

The timing of the recognition depends on the type and nature of the lease modification


Increase in scope - forward start (1/3)Scenario E

Case― 8 year lease of a building ― Lease payments are €400.000 p.a.― Incremental borrowing rate is X%

Scenario― End of Y2 – lease amended to include the rental of the

underground car park from Y5 for €30.000 p.a.― Relative standalone prices are €375.000 for building

rental and €75.000 for the car park― Incremental borrowing rate is Y%

What type of modification is this scenario? Q AThis modification increases the scope by adding an additional asset at a rate which is less than the standalone rate.

Y2 Y5

Effective date of modification

Car park available for use

2


Increase in scope- forward start (2/3)

What is the relative cost based on stand-alone rates?Q A

Allocation of consideration Calculation

Building €357.000 83% * €430.000

Car park €73.000 17% * €430.000

Observable stand-alone prices %

Building €375.000 83%

Car park €75.000 17%

These values are then used to remeasure the lease liability for each component at the modification date

2


Increase in scope - forward start (3/3)

Y2 Y5

What are the four actions to be taken on the effective date of the modification? Q

A

― Re-measure building component― Recognise impact of building re-measurement― Measure car park component― Include the undiscounted cost of the car park

component in the lease disclosures

What are the two actions required in year 5? Q

A

Year 5 is when the car park becomes available for use:― Recognise car park lease ― Remove the undiscounted cost of the car park

from the lease disclosures

2


Lease incentives

Lease incentive: “Payments made by a lessor to a lessee associated with a lease, or the reimbursement or assumption by a lessor of costs of a lessee.”

?

No lease incentive Lease incentive

NO YES

Reduce lease liability /

ROU assetExampleResidual value payment

by the lessor

Examples― Cash amounts received

without any obligation or restriction

― Rent free periods and rent discounts

Does the payment from the lessor meets the definition of a lease incentive (IFRS 16.A)?

No lease incentive: “Payments made by a lessor to a lessee associated with other obligations of the lessee to transfer distinct goods or services to the lessor.”

Profit or loss

Reimbursement of leasehold improvements

LESSEELESSOR

Who controls the asset (‘accounting owner’)?


Reimbursement of leasehold improvements

Facts― Lessee incurs 11.000 cost to

construct a leasehold improvement. ― Lessor agrees to reimburse lessee

for costs incurred up to 10.000― Lessee is accounting owner

Leasehold improvement (amount 11.000) made by lessee

Reimbursement payment made by lessor to the lessee (amount 10.000)

How does lessee account for the leasehold improvement, the lessor reimbursement and the 1.000 overrun?

Q A

― Gross expenditure 11.000 is recognised as PPE asset by lessee

― Lessor reimbursement 10.000 is a lease incentive and reduces the lease payments (lease liability/ROU asset) of the lessee

― Consequently, overrun 1.000 is linear amortisedover the lease term

Lease Improvements


Considerations and Q&A

Considerations

How to identify lease

modifications?

Decreases in scope may lead to

gains or losses

How to record and keep track of modification

adjustments?

Complexity of modifications with multiple

elements

Q&A

Are payments from your lessors lease incentives?

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The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

© 2019 KPMG Advisory N.V., registered with the trade register in the Netherlands under number 33263682, is a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (‘KPMG International’), a Swiss entity. All rights reserved.

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ifrs 16 - masterclass · ―10 years lease of an office floor (f1) ―lease payments are...

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