Aidan Clifford, ACCA Ireland advisory services manager

Onerous contracts

Covid-19 has caused many service and rental contracts to become onerous. Under IFRS, FRS 102 and FRS 105 onerous contracts are provided for immediately, even if the actual cash payments under the contract are not due for more than a year.

An example would be a retailer abandoning a retail unit for which a number of years remain on the lease. Once that retailer closes the unit, they need to immediately provide for the full remaining lease payments upfront. If there was a sublet potential for the abandoned unit, that would reduce the quantum of the onerous contract provision.

Provisions are different to onerous contracts. Provisions can be made only when there is a current obligation because of a past event, a reliable estimate can be made and there will be a payment made. However, when a situation fails the test for the creation of a provision, it may still require an impairment review of the associated assets.

Covid-19 has indirectly affected interest rates and therefore most fair-value calculations

Some specific Covid-19-related examples of onerous leases and provisions, and suggested approaches, include the following:

  • A service contract (cleaning, photocopiers, maintenance etc) for office buildings now surplus to requirements
    Such contracts become onerous once they cease to provide economic benefit and cannot be cancelled.
  • A large leased office building is abandoned and staff all work from home
    A provision for an onerous contract will be made for the remaining lease payments to the first break clause. Temporary abandonment, with a plan to reoccupy, would not be considered an onerous lease.
  • A large owned office building is uneconomic to use unless converted to small offices or has partitions put in place
    A provision for the refurbishment would not be allowed under GAAP until contracts for the renovations are signed, although the business might need to impair the value of the building if the lack of refurbishment reduced the building’s value in use.
  • A photocopier on a three-year lease is now sitting unused in an abandoned office building while all staff work from home and the business model has gone fully digital
    Create an onerous lease provision now for the lease payments up to the first break clause.
  • A software application has been abandoned because Covid-19 caused the user to pivot their business model and made the software redundant
    Any remaining software assets on the balance sheet need to be written off immediately. An associated long-term software support contract would also become onerous and is provided for in full now.
  • A pub expects to reopen shortly and knows that health regulations require it to spend €5,000 on partitions and screens
    No provision can be made until contracts are signed to make the refurbishments. Even if the pub reopens and the renovations have not been done yet, the provision will be the lower of the possible fine or the cost of the renovations.
  • A contract has a late-completion penalty and no force majeure clause
    Provide for the penalty once it becomes 51% (or more) likely that the contract will be delivered late and the penalty clause enforced.
Other Covid impacts

Some of the less obvious effects of the pandemic on accounting treatments include the following:

  • Covid-19 has indirectly affected interest rates and therefore most fair-value calculations for matters as diverse as pension liabilities and the value of complex investments. Most fair-value calculations will need to change, and those changes will usually have a direct impact on reported profit.
  • Loan modifications, loan restructuring or repayment forgiveness can also result in an accounting profit being recognised.
  • Lease concessions or forgiveness/postponement of lease payments can also have a profit-and-loss effect. Note that there is an optional Covid-19 concessional treatment for lease payment forgiveness which will accelerate the tax charge if the concession is claimed. Not claiming the concession will usually just result in a recalculation of the balance sheet lease creditor and right-to-use asset.
  • The Covid restrictions support scheme (CRSS) also has a tax effect, which may need to be reflected in deferred tax this year and in future corporation tax liabilities.
  • For IFRS Standards users, IFRS 5 could see some assets reclassified as available for sale where a decision has been made to dispose of the asset or business. This may change the carrying value of the asset as the accounting changes from cost less impairment to the lower of cost or net realisable value.
  • For property investors, some investment property has diminished in value and that diminution is recognised in the profit-and-loss account.