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FRS 116 LEASES

TECHNICAL BITE-SIZE GUIDANCE: FRS 116

LIM JU MAY AND FELICIA TAY

TREATMENT OF VARIABLE RENT LEASES BY JTC CORPORATION

FRS 116 Leases, the Singapore equivalent of IFRS 16 Leases, was issued by the Accounting Standards Council on 30 June 2016, and is effective for annual financial periods beginning on or after 1 January 2019, for entities under the Singapore Financial Reporting Standards (SFRS) or Singapore Financial Reporting Standards (International) (SFRS(I)). FRS 116 replaces FRS 17 Leases and related Interpretations.

FRS 116 substantially changes the accounting of leases for lessees. The right-of-use accounting model requires the lessee to recognise a right-of-use asset and a lease liability on the balance sheet at the commencement date of the lease, for all leases with a term of more than 12 months, and for which the underlying asset is not of low value.

In Singapore, leases with JTC Corporation (JTC) are fairly common in the marketplace. Such leases are typically more than 12 months and for which the underlying asset is not of low value. Hence, these leases would be accounted for in accordance with the requirements of FRS 116.

Through enquiries received via ISCA’s Technical Helpdesk, we understand that leases with JTC typically include clauses where the annual rent is subject to revision based on prevailing JTC-posted rates. ISCA members have expressed uncertainties as to how such variable rent adjustments should be accounted for under FRS 116.

As this issue is pervasive and relates to a complex accounting area, further discussions and in-depth deliberations are warranted. Hence, the issue was brought onto the agenda of ISCA’s FRC Core Sub-Committee1 for deliberation. The following Tech Bite was developed and issued to share on key points from the deliberations. The Tech Bite also includes an illustrative example to aid in the understanding of the principles being applied through illustrating the numbers that will be recognised in the financial statements based on the Tech Bite’s fact pattern.

HOW ARE VARIABLE RENT LEASES BY JTC TREATED UNDER FRS 116?

Note:

  • Although this technical bite makes reference to FRS 116 Leases, the guidance shared in this technical bite is also applicable to entities applying SFRS(I) 16 Leases.
  • This technical bite applies only to lease arrangements where JTC is the lessor (that is, this technical bite does not apply to sub-lease arrangements).
  • The fact pattern and illustrative example presented in this technical bite are purely illustrative in nature. Entities should determine the lease liability, right-of-use asset, depreciation expense and interest expense according to its specific facts and circumstances. 

Consider the following illustration: Company A enters into a 30-year lease with JTC for the right to use a plot of industrial land for the following consideration:

– Year 1: Annual rent of $300,000

– Year 2 to Year 30: Annual rent is subject to revision based on the prevailing JTC-posted rates but any increase shall not exceed 5.5% of the annual rent in the immediate preceding year (that is, variable rent adjustments)

Under FRS 116, variable lease payments are payments made by a lessee to a lessor for the right to use an underlying asset during the lease term that vary because of changes in facts and circumstances occurring after the commencement date, other than the passage of time.

Q1) At commencement date of the lease, are all variable lease payments included in the measurement of the lease liability and corresponding right-of-use asset?

No. Only variable lease payments that depend on an index or a rate are included in the measurement of the lease liability. Such amounts that are unpaid at the commencement date are included in the measurement of lease liability.

FRS 116 paragraph 28 states that variable lease payments that depend on an index or a rate include, for example, payments linked to a consumer price index, payments linked to a benchmark interest rate (such as LIBOR) or payments that vary to reflect changes in market rental rates.

Q2) Are the annual rent payments from Year 2 to Year 30 by Company A to JTC considered to be variable lease payments that depend on an index or a rate?

This depends on whether the variable rent adjustments reset the lease payments to market rental rates at the dates of the adjustments, that is, the payments vary to reflect changes in market rental rates.

JTC is a statutory board under the Ministry of Trade and Industry and manages a wide range of facilities such as industrial land and business parks to meet the diverse needs of companies based in Singapore.

JTC’s land rent is payable monthly in advance and will be revised to the prevailing JTC-posted rates with a 5.5% escalation cap annually. JTC-posted rates are revised twice a year to reflect changes in market rental rates. Because JTC is Singapore’s principal developer and manager of industrial land and the driver of market rent of industrial land in Singapore, variability of rent payments arising from rent adjustments by JTC would reflect changes in market rental rates, and accordingly qualify as an index or rate in accordance with paragraph 28 of FRS 116.

The variable rent adjustments in the lease agreement between Company A and JTC can be considered to be variable lease payments that depend on an index or rate.

ILLUSTRATIVE EXAMPLE

Using the details provided in the above illustration and the assumptions stated below, the lease liability, cost of the right-of-use asset, interest expense and depreciation expense for Year 1 and Year 2 are as follows:

YEAR 1

Assumptions:

– the discount rate is 3% (Note 1)

– initial direct costs are zero

– no lease incentives, no payments of lease payments at/before commencement date, and no restoration costs

Note 1 The rate to be used is the interest rate implicit in lease, if the rate can be readily determined. If the rate cannot be readily determined, the lessee shall use the lessee’s incremental borrowing rate. FRS 116 defines “lessee’s incremental borrowing rate” as the rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.

YEAR 2

Assumption:

– there is an upward rent adjustment of 5% at the beginning of Year 2 to $315,000 (that is, 105% x $300,000 = $315,000)

Because the lease payments are variable payments that depend on an index or rate, Company A adjusts the lease liability to reflect the change based on the unchanged discount rate.

The adjustment is calculated as the difference between the original lease payment ($300,000) and the adjusted lease payment ($315,000) over the remaining 29-year lease term, discounted at the original discount rate of 3% as follows:

YEAR 3 ONWARDS

The lease liability and right-of-use asset are subsequently re-measured to reflect the revised lease payments arising from changes in lease payments each year. The interest expense and depreciation expense will also be accordingly revised.

Publication date: 23 November 2018
Written by: Lim Ju May and Felicia Tay, Corporate Reporting & Ethics

OTHER PUBLISHED TECH BITES

In addition to the above Tech Bite, ISCA has issued 21 other Tech Bites covering application of principles in various financial instruments standards (FRS 32 Financial Instruments: Presentation, FRS 39 Financial Instruments: Recognition and Measurement, FRS 107 Financial Instruments: Disclosures, FRS 109 Financial Instruments); revenue standard (FRS 115 Revenue from Contracts with Customers), and other standards such as FRS 1 Presentation of Financial Statements, FRS 2 Inventories, FRS 16 Property, Plant and Equipment. For the entire suite of Tech Bites that has been issued to date, please refer to “Technical Bites”.

We encourage and welcome members to share your implementation/application issues of FRSs through our Technical Helpdesk. In the meantime, we will continue to publish Tech Bites to share technical views and insights on financial reporting matters.


Lim Ju May is Deputy Director, and Felicia Tay is Manager, Corporate Reporting & Ethics, ISCA.


1 ISCA’s FRC Core Sub-Committee is a sub-committee of ISCA’s Financial Reporting Committee (FRC). Members of ISCA’s FRC Core Sub-Committee are Mr Reinhard Klemmer (Chairman), Ms Chan Yen San, Mr Chen Voon Hoe, Ms Cheng Ai Phing, Prof Chua Kim Chiu, Mr Aylwin How, Ms Kok Moi Lre, Ms Ong Suat Ling, Ms Soh Lin Leng and Mr Gajendran Vyapuri.

2 For ease of illustration, yearly payments have been assumed.

3 For ease of illustration, yearly payments have been assumed.