By Hayley Keagan
22 January 2019
Upon release of AASB 1058: Income of Not for Profit Entities and AASB 16: Leases, the not-for-profit 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 not-for-profit entities.
A peppercorn lease refers to leases of assets where the required lease payments are significantly below market value.
A 99-year lease provided by Crown land for a nominal amount of $1 per year would need to be accounted for using the following entry upon lease commencement:
Dr Right-of-use asset $X
Cr Liability $1
Cr Income/ retained earnings $X
The amount allocated to the right-of-Use asset is to be determined by reference to its fair value in accordance with AASB 13: Fair 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. Some of the issues that come about include:
- Restrictions to use the asset in a specified manner (e.g. to use crown land only for community purposes).
- Term of the lease, which in some instances can be for up to 99 years or perpetual.
- AASB 13 relies upon the presumption of assets being bought and sold, it thus becomes difficult to fit peppercorn leases into the fair value box.
Initial thoughts in trying to overcome the fair value problem have led many not-for-profits 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 I attended the Australian Accounting Standards Board (AASB) meeting where members considered the issues arising in determining the fair value of these assets, noting the extent of peppercorn leases in the Australian not-for-profit sector. Following the meeting, further consultation occurred and consequently, the AASB released Amendments to Australian Accounting Standards – Right-of-Use Assets of Not-for-Profit Entities. The amendments bring relief to some not-for-profit 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 not-for-profit 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 not-for-profits 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 not-for-profit entities. This could result in a narrow application of the requirements.
- If you are a for-profit entity who has entered into a peppercorn lease, there is no scope to even consider fair valuing the peppercorn lease asset – this creates an inconsistent approach between the for-profit and not-for-profit sector for similar transactions.
If you are, or know of a not-for-profit that has peppercorn leases, subscribe to PKF updates to obtain developing information as it comes to light.
Amendments to Australian Accounting Standards – Right-of-Use Assets of Not-for-Profit Entities
· Provides an option to not apply the fair value measurement requirements to peppercorn leases;
· Applies to Government and Non-Government, not for profit entities;
· Provides additional disclosure requirements;
· Applicable from 1 January 2019, in line with the introduction of AASB 16: Leases;
· Early application permitted if also early adopting AASB 1058: Income of Not for Profit Entities; and
· Temporary option as further guidance is to be sought to find a permanent solution.