NFP Sector Getting Caught In Red Tape With Peppercorn Leases

By Hayley Keagan

25 March 2019

Upon release of AASB 1058: Income of Not for Profit Entities and AASB 16: Leases, the not-for-profit (NFP) sector identified a newly emerging area of accounting – the recognition of peppercorn leases on the balance sheet. These standards are effective from 1 January 2019 for all NFP entities.

A peppercorn lease refers to leases of assets where the required lease payments are significantly below market value.

Previously, AASB 1058 required assets acquired and held for an amount significantly below market value to be recognised at fair value, with the corresponding accounting entry (after accounting for any liability) recognised as income. At the same time, AASB 16 requires an asset be recognised for a right-of-use asset. The interaction of these two standards results in the need to recognise the right to use the leased asset at fair value.

Issues arose when trying to determine the fair value of these types of assets. AASB 13: Fair Value Measurement requires the consideration of restrictions and specialised nature of the peppercorn lease asset.

Initial thoughts in trying to overcome the fair value problem have led many NFPs down the path of obtaining independent valuations of their peppercorn lease assets, resulting in a significant compliance cost as a direct result of the introduction of AASB 1058 and AASB 16.

Recently, the AASB released Amendments to Australian Accounting Standards – Right-of-Use Assets of Not-for-Profit Entities. The amendments bring relief to some NFP entities that have not yet delved into the valuation of peppercorns, but what other impacts does it have?

  • Comparability: the amendments allow for choice of accounting policy. This could lead to some NFP entities recognising significant assets and income related to peppercorns, whilst others have only discussion of the lease arrangement as disclosures in the notes to the financial statements.
  • How long is temporary: the AASB has provided only a temporary change. The issue will need to be addressed again in the future.
  • Transparency: without recognising the fair value of peppercorns, are we really demonstrating the true economic worth of the entity? Are disclosures sufficient to understand the value and dependence from peppercorn leases?

Whilst PKF welcomes the AASB amendments, we believe there is more work to be done before creating a permanent solution.

  • AASB 16 is intended to better show the financial leverage and working capital of the lessee – does recognising a peppercorn lease at fair value achieve this?
  • Recognising a peppercorn lease asset at fair value on the balance sheet is not likely to demonstrate the NFP’s reliance on the lease arrangement – perhaps disclosure regarding the arrangement is more important.                                                                                                                                    
  • The AASB intends to consider peppercorn lease issues as they apply to the private sector and public sector NFP entities. This could result in a narrow application of the requirements.

If you are, or know of an NFP that has peppercorn leases, subscribe to PKF updates to obtain developing information as it comes to light.