In my last article I discussed impairment considerations regarding the new IFRS standard—IFRS 16 Leases—and its implications for a lessee. In this article I would like to show you one more consideration regarding the impairment of leases which may not be so apparent at first glance. Additionally I'll discuss the accounting treatment of an impairment of leases for a lessor.
One more aspect to consider
The impairment of a right-of-use (ROU) asset with respect to leases for lessees reminds me of another often neglected aspect: onerous contracts. Does it ring a bell? Onerous contracts are governed by IAS 37 Provision, Contingent Assets, and Liabilities and are applied to any contract for which unavoidable costs of meeting the contract obligations exceed the economic benefits expected to be received under that contract. Such guidance was greatly applicable for lessees and operating leases. If an operating lease became onerous, based on IAS 37, a lessee would book a provision in amount of the present value of the obligation under that onerous contract.
Now, however, any circumstances (such as lease benefits falling below the level of the lease costs) will be already reflected in the impairment of ROU assets which I discussed in my last article. So how do IAS 37 and IFRS 16 peacefully co-exist? The response lies in the amendment of the scope of IAS 37 which now refers only to leases that become onerous before the commencement date of the lease as defined in IFRS 16 and to the short-term and low value leases accounted for in accordance with IFRS 16.6.
This ultimately leads to another question: what does it mean for the provisions for onerous contracts already recognized for operating leases? Well, it depends on the transition approach: under the modified retrospective approach, for example, an entity can apply practical expedient IFRS 16.C10(b). This would allow it to rely on a previous assessment on onerous contracts in accordance with IAS 37, and to adjust the ROU asset at the date of initial application according to the provision for onerous leases already recognized in the financial statements.
How are lessors affected?
Since my last article on impairment of leases related to a lessee only, one would probably ask: what about the lessor? The lessor carries forward substantively all the accounting guidance from IAS 17 and so continues to distinguish operating leases from finance leases. Similarly, and as outlined in IAS 17, if the underlying asset of an operating lease falls under the scope of IAS 36, then the impairment requirements are to be applied for that asset. Operating and finance lease receivables will be subject to the impairment requirements of IFRS 9.
Every new IFRS brings about not only changes for the treatment of the specified topic, but also more implications outside the standard itself because of the overlap with other standards. IFRS 16 is no different! Therefore you need to be vigilant and always think outside the box.
We will have a look at several more aspects of the new IFRS 16 Leases and its surprising implications, so be sure to check out this blog on a regular basis.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.