Accounting for business rates holidays and rent concessions
This article is part of a series on financial reporting and auditing in the shadow of COVID-19.
Due to the significant impact of the Coronavirus pandemic on trading conditions, many tenants are seeking rent concessions from landlords. Rent concessions may take the form of a one-off reduction in rent, a reduction for a defined period of time or a change in the nature of rent (e.g. fixed rent payments becoming variable). In addition, eligible businesses in the retail, hospitality and leisure sectors will not have to pay business rates for the 2020-21 tax year.
This article is aimed at entities preparing accounts under FRS 102. The accounting approach for rent concessions under IFRS 16 Leases will be different. We will be discussing the accounting for government support schemes and incentives in a separate article.
Business rates holidays
This simply represents a reduction in the rates expense. If the financial year of the business is aligned to the tax year, the entity would simply have a zero rates expense for the year. In most cases, the financial year will not be aligned to the tax year, so time apportionment will be necessary.
It will come as no surprise that when the UK accounting standard FRS 102 was developed the accounting implications of rent holidays due to a worldwide pandemic was not considered.
The ICAEW has now issued guidance in this area. A rent holiday is not a lease incentive unless the landlord also renews the lease agreement. Therefore, the resulting adjustment to the lease expense should be recognised in profit and loss in the period that it arises. Similarly, missed rent payments that are deferred to later periods, should be recognised as creditors.
FRS 102 does not make reference to lease modifications. However, the Big Four UK GAAP handbooks do provide guidance in this area. These suggest that the rent saving should be spread over the remainder of the lease, in the same way as a lease incentive. In the authors view this will be in the majority of cases an accounting over-complication and not in line with the objective of a short term cost reduction provided in response to the COVID-19 pandemic.
In all cases, it would be good practice to include an accounting policy in relation to lease modifications.
Where a landlord allows a tenant to defer the payment of rent to a later period, this does not remove the obligation for the business to settle the debt at a later date and so the rental expense should continue to be charged to profit and loss and a liability created for the amount deferred.
When there is a change in lease payments, the accounting consequences will depend on whether that change meets the definition of a lease modification. The prevalence of rent concessions during the COVID-19 pandemic makes this assessment difficult because of the large volume of contracts that might be affected and because it might be difficult to assess. For example, force majeure clauses were developed without contemplating the COVID-19 pandemic and it might be difficult to determine whether rent concessions offered, or mandated by government, are captured by the operation of such clauses.
Accounting overview (general requirements)
The accounting implications of an agreed change to rents can be very different depending on whether the change was envisaged in the original lease agreement:
- a rent concession not envisaged in the original lease agreement will often be a lease modification, requiring the lessee (tenant) to account for a lease incentive accrual (FRS 102 Section 20), and the lessor (landlord) to revise its operating lease income over the remaining lease term;
- the application of an existing contractual mechanism to adjust rent may represent a variable lease payment, resulting in an adjustment to lease expense / income in the period in which it arises.
Generally, in accordance with FRS 102, a lessee shall recognise the aggregate benefit of lease incentives as a reduction to the expense over the lease term, on a straight-line basis unless another systematic basis is representative of the time pattern of the lessee’s benefit from the use of the leased asset.
Similarly, a lessor shall recognise the aggregate cost of lease incentives as a reduction to the income over the lease term on a straight-line basis, unless another systematic basis is representative of the time pattern over which the lessor’s benefit from the leased asset is diminished.
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