IFRS 16: Lease novation

[Hassan]

We have a datacentre lease contract with a supplier A accounted for under IFRS 16. We entered into a novation agreement to transfer the lease contract from us to a new supplier B. Post novation, Supplier A becomes the head-lessor, supplier B becomes sub-lessor and we are the sub-lessee (i.e. our lease payment obligation is to the sub-lessor now, and they have the obligation to pay rent to the head-lessor).

We continue to use the same lease space (no change how the ROU asset is used by us) and the only change is in the overall consideration (we pay X% management fee in addition to the current lease rental to supplier B).

I think there are two options to account for the change in the arrangement:

Option 1) The novation could be viewed as a lease modification that decrease the scope – i.e. it is accounted for as an early lease termination (IFRS 16.45-46). The contract with the existing supplier A is terminated and replaced with a new contract with supplier B. However in this option there is an immediate P&L hit as the lease liability and right-of-use asset will be remeasured to nil and the difference recognised in profit or loss.

Option 2) the novation of lease contract is accounted for as a lease modification with a change in consideration only. Accounting for the transaction as an early termination impairs the lease ROU asset, with a corresponding P&L charge, even though we continue to use the underlying asset and receives net positive cash flow. On the basis that the leased asset remains under our control during the novation process and the scope post novation is unchanged, the transaction is in substance a lease modification that is a change in consideration only.

Will be great if I can have the community's feedback on the two options.

Thanks in advance!

[Marek Muc]

so from your perspective, it's:
- the same assets
- the same contractual lease term
- higher payments

it's that correct? BTW what's in it for you? I mean, you pay more but receive the same, unless I'm missing something

[Hassan]

Thanks a lot Marek for your reply and apologies for the delay in my reply.

That's correct, we've the same assets, contractual lease term but with higher payments. This counterparty has a wider engagement with us and help with cost efficiencies elsewhere so we agreed to take a hit (in the form of higher lease payments) in the novated lease contract which is overall mitigated with benefits elsewhere in the business.

[Marek Muc]

OK so why did you wrote that

Option 1) The novation could be viewed as a lease modification that decrease the scope

where's this scope decrease then?