Accounting for operating leases
To help with the financial downturn caused by the COVID-19 pandemic many leases have been granted rent concessions by their landlords. This could take the form of a temporary rent reduction or a rent holiday. Due to a lack of any clear guidance in existing standards there have been differing views as to how concessions such as these should be accounted for, leading to inconsistencies. Some have argued that any concessions granted should be recognised over the remaining lease term, which would provide a similar approach to that adopted in respect of lease incentives designed to encourage a lessor to enter into or renew a lease. Others though believe that this treatment does not adequately reflect the exceptional circumstances that the pandemic has created, and the temporary nature of any concessions being granted.
The Financial Reporting Council (FRC) has now sought to address this issue, amending financial reporting standards to provide clarity on the required approach when rent concessions are granted. These changes will apply to users of FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland, the accounting standard that the Charity SORP is based upon.
Under the amended treatment, lessees will be required to account for any change in lease payments arising from rent concessions over the periods that the change in lease payments is intended to compensate. It will only apply to temporary rent concessions occurring as a direct consequence of the COVID-19 pandemic that meet the following conditions:
- the change in lease payments results in revised consideration for the lease that is less than the consideration that was payable immediately preceding the change
- the reduction in lease payments affects only payments originally due on or before 30 June 2021
- there is no significant change to other terms and conditions of the lease
This approach is considered by the FRC to best reflect the economic substance of the benefit arising from any rent concessions being granted and their temporary nature and will provide more relevant information for the users of financial statements. It will also provide closer alignment with the treatment of government support schemes available in response to the pandemic accounted for as grant income.
Where the financial statements are prepared in accordance with FRS 102 lessees will be required to disclose the changes in lease payments recognised, supplementing the existing requirement to disclose future operating lease commitments. They may also need to amend their accounting policy for recognising operating leases to make clear the approach that is being followed.
Lessors will account for rental income on the same basis, recognising the impact of any concessions granted over the period the changes in lease payments are intended to compensate.
This amendment to FRS102 applies for accounting periods beginning on or after 1 January 2020, although earlier adoption is permitted provided that the fact that the entity is doing so is clearly disclosed in the accounts. The final amendments can be found at https://bit.ly/2Tcawq4