Covid-19 has brought about many changes in the world. One of these is how we use office space.
Even before the pandemic started, many forecasts suggested that the demand for shared workspaces would increase. Companies are looking for more flexible lease agreements while offering their employees opportunities for collaboration. Shared working spaces can meet both these objectives.
A shared workspace is a space that is “shared by many people at different times. The workspace is static, the occupants are dynamic.” [definition from spaceiq.com]
From an accounting perspective, it is essential to analyse whether or not the rental for a shared workspace meets the definition of a lease. This article only covers accounting aspects under the International Financial Reporting Framework (IFRS).
If it is a lease, IFRS 16 Leases requires the tenant to recognise a right-of-use asset and lease liability, unless it is a short-term lease. From the lessor’s perspective, if the rental agreement is not a lease the lessor is deemed to be providing a service and should recognise revenue under IFRS 15 Revenue from Contracts with Customers.
What is a lease?
A lease is a right to use an asset for a period of time in exchange for “consideration”. IFRS 16 requires that an agreement meets the following three criteria before it qualifies as a lease:
- there must be an identifiable asset;
- the customer must receive “substantially all” the economic benefits from the asset; and
- the customer must have the right to direct the use of the asset.
Why would rental of a shared workspace not meet the definition of a lease?
A shared workspace is usually an area that is utilised as and when needed. An individual uses that space for a limited period and someone else will use it when the individual leaves, instead of the space sitting idle. They are often used on a first-come, first-serve basis, and the desks are not allocated to specific users.
A shared workspace agreement often specifies the amount of space, or a number of desks, there is not always an identifiable asset as the lessor:
- has the ability to substitute alternative assets throughout the period of use; and
- would benefit economically from substituting the asset.
In simpler terms, the lessor can allocate different desks to individuals or move the desks around in the building. The lessor would benefit from these changes as the desks do not remain idle.
Are there other important considerations?
If the contract qualifies as a lease agreement, two other considerations are critical.
1. Consider the lease term
For short-term leases of less than twelve months, lessees have an accounting policy choice to recognise the lease expense on a straight-line basis over the lease term. The lessee need not recognise a right-of-use asset in this case.
The lease term is the non-cancellable period of the lease. The lease term includes the period for which the lessee is reasonably certain to extend or terminate the lease under an extension or termination option.
The non-cancellable lease period represents the part of the lease that is enforceable.
A lease is no longer considered enforceable when:
- both the lessee and the lessor have the right to terminate the lease (without permission from the other party); and
- the lessee and lessor will only pay an insignificant penalty.
It is important to scrutinise the lease contract carefully to identify terms that allow both parties to cancel the lease of the shared workspace. If this is allowed, penalties payable by either party should also be considered. The penalty can be financial or economic. An example of an economic penalty is the cost that the lessee will incur to find a new office space.
If both parties have the right to cancel the lease with only an insignificant penalty (if any), the lease is not regarded as enforceable from the time that both parties have that right. Lease payments, which are considered variable lease payments, are expensed as incurred over the unenforceable period.
2. Identify non-lease components
Often, additional services are provided alongside the lease of shared workspace. These services can include the use of office WiFi, printers and kitchen equipment. As tenants do not have exclusive use over these items, the benefits do not meet the lease definition.
IFRS 16 requires the identification of non-lease components. Non-lease components should be accounted for under its relevant standard and not IFRS 16, unless the lessee elects to apply the IFRS 16 practical expedient.
The practical expedient allows the lessee to account for the lease- and non-lease components as a single lease component.
If you, or your company utilise a shared workspace, it is important to carefully assess whether the rental agreement meets the definition of a lease. If the lessor has substantive substitution rights, there is probably no identifiable asset, and the rental agreement falls outside the scope of IFRS 16.
If the contract for the shared workspace is a lease, is the lease term enforceable? What is your policy election regarding an enforceable lease term that is 12 months or less?
Where there are non-lease components, lessees may apply the practical expedient and account for the lease- and non-lease components together.
By Nelia Joubert