When leases are acquired in a business combination, their accounting treatment is “reset” as if they were brand new leases as at acquisition date in the (consolidated) financial statements of the acquirer.
This means that any previous lease liability or right-of-use assets previously recognised by the acquiree/vendor is not simply “rolled up” into the acquirer.
To explain further, the areas of the “reset accounting” that acquirers will need to take note of are detailed below.
(a) Discount rate (used to present value future lease payments)
From our previous Cheat Sheet Applying Discount Rates under the New Lease Standard (NZ IFRS 16) you will recall that the discount rate is determined at a lease’s commencement date (or adoption date), and must incorporate four key parameters: (i) jurisdiction; (ii) asset type; (iii) lease term; and, (iv) amount.
Accordingly, the application of “reset accounting” for acquired leases may mean that discount rates that may have been previously determined and applied by the acquiree/vendor may no longer be appropriate.
(i) As at what date?
“Reset accounting” requires the discount rate to be (re)determined as at the acquisition date.
Therefore, the economic conditions present at acquisition date may have changed from those that existed at the date the original discount rate was previously determined (i.e. commencement (adoption) date).
(ii) What lease term- and amount - parameters are used?
“Reset accounting” requires the discount rate to be determined based on the remaining lease term (iii) and remaining lease payments (iv) from acquisition date, rather than the original lease term and original lease payments that existed at commencement (adoption) date.
Because leases will be part way through their terms as at acquisition date, both (iii) and (iv) will have changed, and this must be taken into account when the discount rate is determined at acquisition date - depending on whether the acquirer determines it is likely to make use of renewal options that the acquiree/vendor did (or did not) include in determining the lease term.
(iii) Whose discount rate is determined?
The discount rate is based on the entity that is the contractual lessee subsequent to the business combination.
Accordingly, the “form” that the business combination takes will determine which entity’s discount rate is being determined at acquisition date:
- Majority share buy-out: The acquiree’s
- Trade and net asset buy-out: The acquirer’s.
(b) Adjustments for favourable or unfavourable lease terms
As has been previously required under NZ IFRS 3, an acquirer is required to recognise amounts that reflect the inherent benefit (or not) of when the terms of acquired leases are more (or less) favourable than that of market lease terms that exist as at acquisition date.
However, rather than recognising this as a separate item in the acquirer’s balance sheet as has been done previously, any such amounts are now recognised as adjustments against the right-of-use asset as at acquisition date.
 Or, the date of adoption to NZ IFRS 16 if the acquiree/vendor previously utilised the Modified Retrospective Method when adopting to NZ IFRS 16.