Commercial Property - Operating Lease Considerations

Ahead of our Commercial Property update on Thursday, we take a look at Operating Leases, with a focus on the move from Section 20 FRS 102 to IFRS 16 and the benefits to both landlords and tenants of rent free periods. As regulatory landscapes evolve, staying abreast of changes is paramount for maintaining compliance and fostering trust within financial markets and tenants.

Move from Section 20 FRS 102 to IFRS 16

FRS 102 Section 20 is due to be substituted by IFRS 16 and mandates significant changes in lease recognition and reporting, especially for lessees. The expected effective date is 1 January 2026 but this date has not been confirmed yet. Under IFRS 16, lessees must recognise all leases on the balance sheet as Right-of-Use Assets, regardless of whether they are classified as finance or operating leases. In contrast, FRS 102 Section 20 makes a distinction between finance and operating leases. Finance leases are recognised similarly to IFRS 16, with the lease obligation and Right-of-Use Asset both reflected on the balance sheet. However, for operating leases under FRS 102 Section 20, lease payments are expensed on a straight-line basis over the lease term rather than being recognised as assets and liabilities on the balance sheet. The primary objective of IFRS 16 is to bring most operating leases, previously off-balance sheet, onto the balance sheet to enhance transparency and clarity in financial reporting.

Measurement and Disclosure Under IFRS 16

  • Measurement of Lease Liabilities - Lease liabilities are initially measured at the present value of lease payments, discounted using the lessee's incremental borrowing rate unless the interest rate implicit in the lease is readily determinable.
  • Measurement of ROU Assets - ROU assets are initially measured at the amount of the lease liability, adjusted for any lease payments made at or before the commencement date, plus any initial direct costs incurred by the lessee, and minus any lease incentives received.
  • Subsequent Measurement - Lease liabilities are subsequently measured using the effective interest method, and ROU assets are depreciated over the lease term or the useful life of the underlying asset, whichever is shorter.
  • Disclosure Requirements - IFRS 16 includes extensive disclosure requirements for lessees and lessors, including information about lease commitments, maturity analysis of lease liabilities, and significant judgments and estimates used in applying the standard.

Lessees can elect not to recognise right-of-use assets and lease liabilities for short-term leases, defined as leases with a lease term of 12 months or less and leases of low-value assets (e.g., laptops, small equipment) regardless of lease term. Preparing for implementation involves several steps, including understanding the standard, assessing lease inventory, gathering lease data, evaluating existing systems and processes, developing a comprehensive implementation plan, and ongoing monitoring and review post-implementation. The abolition of operating leases for lessees represents a significant stride towards increased transparency in financial reporting, providing stakeholders with a more comprehensive view of a company's financial commitments. As regulatory landscapes evolve, staying abreast of such changes is paramount for maintaining compliance and fostering trust within financial markets.

Rent Free Periods

A rent-free period, often negotiated between landlords and tenants, offers tenants temporary relief from rental expenses, allowing them to utilise leased space without incurring rent payments. Typically, this concession is offered by landlords to attract tenants or to facilitate the tenant's transition into the premises. For tenants, it provides financial relief and flexibility, allowing them to allocate resources towards other startup costs or operational expenses. Landlords benefit from quicker occupancy and enhanced property appeal, but must carefully consider the financial implications of forgoing rental income during these periods, ensuring clear documentation and mutual understanding of terms in lease agreements.

Accounting for rent-free periods involves distinct implications for both tenants and landlords. Tenants recognise the benefit received during such periods as lease incentives, amortising their value evenly over the lease term to reduce rent expense. Similarly, landlords account for rent-free periods as lease concessions, spreading their impact on rental income over time. Such adjustments affect financial statements, requiring transparent disclosure in notes to provide stakeholders with a comprehensive understanding of lease arrangements

Overall, while a rent-free period offers benefits for both parties it necessitates careful consideration of its accounting implications and potential long-term impacts on property valuation. Clear communication and understanding of the terms and conditions are crucial to ensure a mutually beneficial arrangement and to maintain transparency in lease transactions.

Commercial Property Update - Register Now

Join RBK, together with James Nugent, Senior Director at Lisney who will provide an industry overview of what they are seeing in the market, Roisin Bennett, Head of Property at Reddy Charlton Solicitors will provide insight into topical legal considerations in relation to commercial lettings, including the impact of recent Court decisions. RBK’s VAT Director, John Moore, will discuss some of the pitfalls and opportunities we are seeing in the market and key VAT considerations around sales of property, lease terminations, surrenders and lettings.

DATE: Thursday, 11th April 2024
TIME: 12.30pm - 2.00pm
VENUE: Clayton Hotel Leopardstown, Central Park, Sandyford Business Park, Dublin, D18 K2P1.

Who should attend?
This hybrid event is of interest to real estate investors and businesses who may be considering moving property or varying an existing lease, as a landlord or a tenant.

Contact Us:

For further details on IFRS 16 and rent free periods, contact our Audit & Business Advisory Team:

  • Brendan Mullally, Partner - 01 6440100
  • Caoimhe Lawlor, Manager - 01 6440100