Break clauses
Landlords in Dublin and many other city locations have been put on notice for the purposes of break clauses in commercial leases, as Covid-19 disruption and new work practices put pressure on rents. This trend is causing a few accounting issues.
Triggering a break clause reduces the value of commercial property, which will be reflected in property owners booking losses this year. Many of these properties are at least part-owned by pension funds, so the knock-on effect will be felt by a broad swathe of investors.
Users of IFRS Standards would have initially calculated right to use assets under IFRS 16 on the assumption that break clauses would not be activated; these will now need recalculation. Although much of the effect will be in the balance sheet, there will be some profit and loss consequences as well.
FRS 102 users are unlikely to have property leases on the balance sheet, so non-IFRS companies will see no effect on their lease calculations. However, the useful lives of equipment and fixtures will need reassessing and may require impairment charges if they cannot be reused in the new building or by employees working from home. Large boardroom display screens being repurposed for domestic use once a building lease has been cancelled are unlikely to create a value in use in excess of their carrying value.
Covid consequences
An observations paper from the Irish Auditing and Accounting Supervisory Authority (IAASA) looks at how Covid-19 and Brexit will have a profound effect on financial statements. One of the main issues is that the change in economic activity is affecting forecasts, which has a knock-on effect on fair value calculations. Particularly affected are level 3 (mark to model) fair value calculations, value in use, expected credit losses, discount rates and leases.
In its paper the regulator makes clear that it expects issuers to provide entity-specific and comprehensive disclosures that enable users of financial reports to understand. Disclosures should include:
- the impact that the Covid-19 pandemic has had on issuers – on their financial performance, financial position, cashflows and risks
- the sources of estimation uncertainty and changes in the key assumptions underpinning assets, liabilities, income, expenses and cashflows
- the mitigating actions taken to respond to the pandemic
- the expected impact on the future financial performance, financial position, cashflows and risks
IAASA expects disclosure of matters such as loan covenant waivers, liquidity, impairment, market restrictions, strategy changes, temporary closure, health and safety of employees, and insights into future trends. There is also a reminder of the requirement to prepare a maturity analysis for loans.
The effect of Covid-19 is so pervasive it would be a challenge for any entity to determine that loss impairment will not apply
IAASA states that IAS 36.9 requires an impairment review to be performed when ‘there is any indication that an asset may be impaired’. The effect of Covid-19 is so pervasive that it would be a challenge for any entity to determine that it is unaffected.
Banks are faced with having to re-estimate expected credit losses under IFRS 9. IAASA identified the need for management control over the assumptions used and the use of forward-looking information in the expected credit loss calculations. It is also worth consulting the public statement from the European Securities and Markets Authority on the Accounting implications of the Covid-19 outbreak on the calculation of expected credit losses in accordance with IFRS 9.
IAASA has also warned issuers to exercise caution in presenting the financial impact of Covid-19. The presentation of notional revenues forgone as a result of the pandemic is not permitted, and the inclusion of Covid-19 costs need to be carefully dealt with when those costs would have been incurred anyway.
