NZ IFRS 16 Leases
The new leases standard is expected to impact a large number of entities because many businesses lease items of property, plant and equipment, and except for certain low value and short-term leases, these right-of-use assets will need to be capitalised on the balance sheet, together with the related lease liability.
Some issues to note on first-time adoption of NZ IFRS 16:
- Determining whether you have a ‘lease’ to capitalise under NZ IFRS 16 is not always a straight-forward process. Some ‘lease’ contracts may not meet the definition of a lease in NZ IFRS 16, and conversely, some service agreements will need to be accounted for as ‘leases’.
- There are three possible transition methods to choose from, and each will result in a different impact on earnings after transition:
- The full retrospective method is the most complicated and time-consuming to apply in practice.
- The simplest transition method is ‘modified retrospective method #1’, where comparatives are not restated, and the right-of-use asset is simply equal to the lease liability on transition date (i.e. no adjustment is made to opening balances of retained earnings). However, this is likely to result in a higher balance in the right-of-use asset on transition date, and therefore higher amortisation expense in future, and higher EBITDA.
- Modified retrospective method #2 should result in a lower right-of-use asset, and therefore lower amortisation in future, but calculations to determine the right-of-use asset are more complex than approach #1.
- Ongoing management of lease accounting could turn into a nightmare for many entities, particularly where variable lease payments need to be reassessed each year (e.g. CPI or market increases), or where there are modifications to leases (which require adjustment to the discount rate).
- Entities with several leases may wish to consider one of BDO’s technology solutions to deal with lease accounting. Please refer to more information about BDO Lead on our web site.
For more information on specific aspects of lease accounting, please refer to our previous editions of Accounting Alert and other training resources listed below:
Our IFRS in Practice also provides detailed guidance and examples on the application of NZ IFRS 16.
NZ IFRIC 23 Uncertainty over Income Tax Treatments
NZ IFRIC 23 requires entities to calculate their current and deferred tax assets and liabilities as if the tax authorities were going to perform a tax audit, and the tax authorities knew all the facts and circumstances about the entity’s tax position.
We are unlikely to see changes to financial statements in the way entities recognise tax assets and liabilities if it is probable (more than a 50 per cent chance) that the tax authority will accept the uncertain tax position.
However, if it is not probable that the tax authority will accept the uncertain tax position, the effect of the uncertain tax position will need to be included when measuring the income tax expense and related current and deferred tax assets and liabilities, using either a ‘most likely amount’ or ‘expected value’ measurement method.
This is likely to have a significant impact on the quantum of income tax liabilities for entities subject to judgmental tax areas such as transfer pricing. Boards and audit committees who have not already done so, need to ensure that an extensive tax review is conducted, firstly to identify all uncertain tax positions; and then to assess the impact on the financial statements.
Please contact a member of BDO’s Tax team if you require assistance.
COVID-19 (Including rent concessions)
COVID-19 is presenting many accounting challenges for preparers and auditors of 30 June 2020 financial statements, including consideration of going concern, impairment of assets (including expected credit losses on trade receivables and loans), modification to financial liabilities because of payment deferral or changes to loan conditions, measurement of revenue, lease rent concessions, and many more.
Our IFRB 2020 03 provides a useful summary of the possible impacts you should consider when preparing June 2020 financial statements. The following Accounting Alert articles also provide information about the accounting implications of COVID-19:
Please contact BDO’s IFRS Advisory team if you require assistance in accounting for COVID-19 related issues.
COVID-19-related rent concessions
Changes to the terms of leases that are not contemplated in the original lease agreement are ordinarily accounted for as modifications under NZ IFRS 16. This means that lease liabilities are remeasured at the date of modification using an updated incremental borrowing rate (IBR) at modification date, and the impact of the remeasurement is adjusted against the carrying amount of the right-of-use (ROU) asset, with amended amortisation expense on the ROU asset being recognised over the remaining period of the lease. Modification accounting could be a time-consuming and burdensome process for many lessees that have negotiated COVID-19 rent concessions with landlords, firstly to conclude whether such concessions were contemplated in the original terms of the lease, and secondly to determine new IBRs at modification date.
Our June 2020 Accounting Alert article summarises the NZASB’s recent amendment to NZ IFRS 16 which permit lessees, as a practical expedient, not to assess whether particular COVID-19-related rent concessions are lease modifications. Instead, lessees that apply the practical expedient would account for those rent concessions as if they were not lease modifications. Although lease liabilities will need to be recalculated at the date the concession is agreed between the lessee and lessor, lessees will not need to revise the IBR, and this should save a considerable amount of time.
Our more detailed article in this newsletter provides detailed examples, including journal entries, on how to account for rent waivers and deferrals.
For more on the above, please contact your local BDO Representative.