Scene: Meeting room in London based office block
‘And if you just press this button here; out pop the IFRS 16 discount rates’
Over the last couple of weeks there has been a familiar format to my IFRS 16 conversations; firstly, I’m shown a new shiny piece of IFRS 16 software (modules from France and Australia this week); then the journal template; and finally, a table of discount rates.
‘How are you going to recalculate the discount rates going forwards?’ I ask.
After a pause…’yes, of course, when we enter into new leases, we will need to calculate a new discount rate’
‘And what about for lease modifications or changes in key judgments?’
A longer pause…
‘Don’t worry, I’m not here to tell you that you have a load more work to do. However, it would be worth spending a bit more time looking at how your discount rates link into the key judgments you have made during your transition. To save the headache of doing it in the heat of the moment.’
‘So, what do I need to think about then?’
If you are like most people who have spent time looking at IFRS 16, you will remember that it mentions lease modifications. How I remember a lease modification under IFRS 16 is that it is a change in terms that was not in the original lease agreement. Think change in what you are leasing, the lease term or a rent review. If you want to open the book again; its paragraphs 44-45.
When a lease modification occurs, whether as a separate lease or a remeasurement to the existing, a new discount rate needs to be determined. Logically this makes sense as the lease contract has changed.
What we are seeing missed is not necessarily the big contract changes (a new floor); but rather the impact of the changes to the significant judgments made on inception.
A good example is the judgment around whether management are reasonably certain to renew or terminate a lease. Their intention at the date of transition will have been made with the facts at hand (or potentially by an isolated finance team). Intentions change and, on that date, the resulting adjustment to extend or shorten a lease term will need a new discount rate [para 40].
Changes as a result of judgments, rather than changes to contracts are likely to affect most companies; and should become business as usual. Having been through numerous projects, these judgments are typically put into a technical paper, passed through an auditor and then filed away. Making sure that you are creating a process to capture these as part of your transition will set you up for success (more on this soon).
Good news though; any changes to future lease payments as a result of change in an index or rate or changes in the amounts expected to be paid under a residual value guarantee, do not require a revised discount rate [para 42-43].
Not all is lost.
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