What can make Local GAAP accounting more complex?
While Local GAAP sets out clear principles for lease accounting, real-life situations do not always follow the original plan. Early terminations or changes to lease agreements often raise questions about the accounting treatment. Below, we look at two common scenarios and how they are handled under Local GAAP.
When a lease does not unfold as originally agreed, the accounting must be adapted to the new situation. This can include early termination or changes to the lease terms. How this plays out in the accounts becomes clear in the two examples that follow.
Example 1: Early termination of a lease
When a lease is terminated before the end of its contractual term, both a right-of-use asset and a remaining lease liability are still recognized in the accounts. These balances are rarely equal. The difference between them represents the equity that has built up over the life of the lease, in other words, the accumulated result associated with the agreement.
– When a lease is derecognized, the starting point is the lease liability, as this represents the underlying economic obligation. The liability is removed first, followed by the asset. Any difference between the two amounts remains as an accumulated result and needs to be recognized through the income statement as other operating income, explains Richard Nilsson, IFRS 16 and Local GAAP expert.
He continues:
– In practical terms, this means that when a liability (credit) and an asset (debit) with different carrying amounts are removed, a balancing amount arises and is initially reflected in equity. To ensure the accounting is correct, this amount must then be recognized through the income statement.
To illustrate this with an example, consider a lease that is terminated early with a remaining asset of SEK 78,000 and a lease liability of SEK 80,000. Upon derecognition, the liability of SEK 80,000 and the asset of SEK 78,000 are removed from the balance sheet. The remaining difference of SEK 2,000 reflects that depreciation has exceeded amortization by that amount over the life of the lease. Since the lease liability represents the underlying obligation, the SEK 2,000 difference is recognized in the income statement as operating income. In effect, the excess depreciation recognized in earlier periods is reversed.
Example 2: What happens when a lease is modified or extended?
When a lease is extended or otherwise modified and qualifies as a finance lease, the price has already been determined at the outset of the agreement. As a result, no remeasurement is required. The lease continues on the same basis, with amortization of the liability and depreciation of the asset proceeding as before. The starting point is the carrying amounts of both the asset and the liability at the time of the extension.
– The most common scenario is that a residual value remains at the end of the original lease term. In many cases, the asset has been depreciated to a level that corresponds to the remaining lease liability. When this is the case, the lease simply continues on the same basis as before, using the original acquisition value, with amortization of the liability and depreciation of the asset continuing from that point, he explains.
– It is also worth noting that it is fairly common for the interest rate to change slightly and for the finance provider to apply a different fee when a lease is extended. However, this varies from one agreement to another, Nilsson concludes.