Curious case of lease concession

IFRS 16 or Ind AS 116 (converged standard of IFRS 16) is one of standard which brought significant changes in how the accounting for leases are done, predominantly, in the books of lessee. Without going into explaining how these standards work, I am going to specifically talk about a practical difficulty faced by the entities in applying the standard. The difficulty pertains to insignificant changes in future minimum lease payments from what were originally agreed upon at the time of signing of lease arrangement both by lessor and lessee.

To work with these standards, a lease must have following components (to the least):

a) Future minimum lease payments;

b) Leased space;

c) Lease term / period; and

d) An incremental borrowing rate / discount rate.

Without all these components, recognition of lease as per these standards is not possible. At initial recognition, lease liability and corresponding right-of-use asset is recognised. On subsequent recognition, lease liability is adjusted with interest and periodic payment towards lease while right-of-use asset is depreciated on straight-line basis over the period of lease. The ultimate outcome of this calculation is that at the end of the lease period i.e. the day when lease arrangement comes to an end, both lease liability and right-of-use asset will become ZERO (assuming all components remain same as they were at the beginning).

Readers should also know the fact that all components mentioned supra, may change during the course of the lease as agreed by both lessor and lessee. Any subsequent change may be termed as "lease modification". Why I am saying 'may be' and not 'shall be' is because of the definition (of lease modification) prescribed by these standards. In terms of Ind AS 116, lease modification means,

"A change in the scope of 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 underlying asset, or extending or shortening the lease term, or changes in consideration. It is important to note that, by definition, any change in any component (as prescribed above) is lease modification except of change in incremental borrowing rate (IBR) or discount rate. Consequently, sole change in IBR is not a lease modification and hence need not be taken into account as such. It is only when there is change in other component(s) of the lease, a revised IBR is considered for subsequent accounting.

In most of the cases, accounting for lease modification will mean re-computation of lease liability and right-of-use asset all together, no matter how insignificant the change is. Take for example a case where lessee has got an immaterial discount on lease payments for say 1-2 months only. For this discount as well, lessee has got to treat this as lease modification only and re-compute both lease liability and right-of-use asset.

On the backdrop of Covid-19, the standard setters provided for practical expedient to recognise lease modification on account of reduction in lease payments as lease concession directly to the statement of profit and loss without changing the lease schedule. However, this practical expedient was allowed to be used till 30 June, 2022 only. Consequently, after this date, all changes have to be accounted for as lease modification only.

I strongly believe that standard setters must provide for this practical expedient forever, may be only for insignificant change in the component(s) of the lease which are not frequent in nature. e.g. instances of random discount on lease payments by lessor. There is no point in updating whole lease schedule just for random immaterial changes.

Disclaimer - The views are of author only and in his personal capacity.