Hybrid work arrangements – we’re feeling renewed!

The financial reporting challenges arising from Covid 19 may largely be receding into the past…

…but the aftermath yields its own issues. One of these is the new prevalence of hybrid-work arrangements under which companies provide their employees with more flexibility to work partly in the office and partly remotely. Here’s the background to an issue recently considered by Canada’s IFRS Discussion Group:

  • Entity A is beginning to execute its hybrid-work model. Given that its employees are only expected to work on-site one to three days per week, Entity A has developed a plan to close three smaller regional offices and move the workforce into its largest building located in the downtown core. Employees will use a hoteling system to reserve a workspace in the office.
  • Entity A had originally determined that it was reasonably certain it would renew the lease for one of their smaller regional offices for an additional five-year term after the initial term (Office 1).
  • When nine months remain in the initial term of the lease, Entity A revises its budget and decides it will no longer renew the lease for Office 1.
  • When six months remain in the initial term of the lease, Entity A gives notice to the landlord that it will not renew the lease beyond the initial term.
  • Given employees are still working remotely at this time, Entity A has not begun to vacate the building.

The group discussed at what point the entity should reassess whether it is reasonably certain of exercising the renewal option for Office 1, as required under IFRS 16 if there’s a significant event or change in circumstances within the entity’s control. While most group members agreed that this point has been reached when notice is given to the landlord, more judgment is required – focusing not only on the entity’s intentions but also on its economic incentives – in considering whether it was reached earlier, at that nine-month point. These are some of the points made:

  • an entity should consider how formal its budgeting process is, and how easily it could change its budget. At many large organizations, budget preparation is a formal process involving careful planning, multiple approvals and communication across the organization. Once the budget is finalized, such organizations are reasonably certain that they will execute business decisions based on the budget. Changing the budget is rare, and involves the same degree of planning, approvals and communication across the organization. In contrast, many smaller organizations have a more flexible budgeting process. For these types of organizations, the internal business decision made with nine months remaining in the lease term might not be sufficient to conclude that the entity is reasonably certain that it will no longer renew the lease.
  • the communication strategy of the business decision not to renew the lease could also impact whether reasonable certainty exists. For example, the entity may have communicated this business decision to the employees who work out of this office. Reversing this decision might lead to employee retention issues as many employees might now prefer to work from home.
  • an entity might consider indirect economic consequences of renewing the lease. For example, an entity might demonstrate that it experienced significant cost savings as a result of employees working from home during the pandemic. As a result, asking employees to permanently return to the office might not make economic sense for the company.

The group considered a related fact pattern where the entity also decides to vacate a single floor of the building located in the downtown core, using a hoteling system that will reduce the need for office space. The common area maintenance (CAM) expense is a significant (25-30 per cent) proportion of the expense for the downtown office space, and under the terms of the lease contract, the entity must continue to pay the full contractual expense. The group considered whether an onerous contract should be identified under IAS 37 for the portion related to the soon-to-be-vacated floor: this would be required if each floor constituted a separate “unit of account.” Most group members thought this isn’t generally required: “IAS 37 does not provide any guidance on breaking the contract down into components when performing the onerous contract assessment….had the IASB intended for onerous contracts to be assessed at the component level, this would have been stated explicitly in the standard.” However, as always “entities should assess the specific facts and circumstances when determining the level at which to perform the onerous contract assessment” – for example, the answer might differ if an entity has a separate contract for each floor of the leased building.

The group also discussed the accounting for termination penalties that may be negotiated with the landlord, but I’ll let you look that one up for yourself. If you’re lucky, maybe you can do it from home!

The opinions expressed are solely those of the author

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