Loss-making leased outlets (right-of-use impairment) and restoration obligations

Multi-branch F&B and hotel operators sign long leases with reinstatement clauses, and individual outlets can turn loss-making long before closure. Under IFRS 16 the rent is already in the lease liability, so a loss-making outlet is reflected by testing its right-of-use asset and fit-out for impairment under IAS 36, not by an IAS 37 onerous lease provision that would count the same rent twice. IAS 37 still governs restoration obligations and any unavoidable costs that sit outside the lease liability; delaying the impairment test or these provisions overstates assets and interim profit.

Is there an indication that a specific outlet is impaired (sustained trading losses, a decision to downsize or close part of it, adverse local market changes), requiring its right-of-use asset and fit-out to be tested under IAS 36, usually at the outlet (cash-generating unit) level? Are there unavoidable costs tied to the outlet that sit outside the lease liability (non-lease service or maintenance contracts, or short-term and low-value leases under the IFRS 16 exemption) and exceed the economic benefits expected from them, indicating an onerous contract under IAS 37? Does the lease require restoring the unit to its original condition at expiry, and has that obligation been recognized as a provision and included in the cost of the right-of-use asset, measured at the best estimate and discounted where the time value of money is material?

1. At each reporting date, assess each underperforming outlet for indications of impairment (sustained losses, falling footfall, a decision to downsize or close part of the outlet).
2. If an indication exists, test the outlet's assets, including the right-of-use asset and leasehold improvements, for impairment under IAS 36, usually at the outlet (cash-generating unit) level, comparing the carrying amount with the recoverable amount (the higher of value in use and fair value less costs of disposal).
3. Recognize any impairment loss immediately in profit or loss, allocated across the outlet's assets; do not recognize a separate provision for the remaining rent, because the rent is already measured in the lease liability.
4. Do not wait until the outlet has physically closed; test as soon as an indication arises, and never provide for future operating losses as such.
5. Identify unavoidable costs linked to the outlet that sit outside the lease liability: non-lease service, maintenance or supply contracts, and short-term or low-value leases accounted for under the IFRS 16 exemption. A lease that becomes onerous before its commencement date also falls under IAS 37.
   6. For such contracts, first recognize any IAS 36 impairment on assets used in fulfilling them, then recognize an onerous contract provision if the unavoidable costs (the lower of the cost of fulfilling and the cost of exiting) exceed the economic benefits expected, provided a present obligation exists, an outflow is probable and the amount can be estimated reliably.
   7. Separately, review leases for reinstatement/dilapidation clauses; where a legal or constructive obligation to restore exists, recognize a restoration provision at lease commencement (or when the obligation first arises, e.g. on installing leasehold improvements that must later be removed), not as expiry approaches.
   8. Include the restoration cost in the cost of the right-of-use asset (or of the related leasehold improvement) and depreciate it over the relevant period.
   9. At each reporting date, reassess impairment indicators (reversing a past impairment if the recoverable amount recovers, up to the carrying amount that would have existed without it), update any onerous provision for changed expectations or remaining term, update the restoration provision for changes in cost, timing or discount rate, and recognize the unwinding of the discount as a finance cost.
   10. Do not provide for a merely possible (rather than probable) obligation; disclose it as a contingent liability instead.

Measure the outlet's recoverable amount as the higher of value in use and fair value less costs of disposal. In value in use, exclude the lease payments already recognized in the lease liability and exclude that liability from the carrying amount tested, so the rent is not counted twice; base cash flows on reasonable and supportable forecasts and discount them at a pre-tax rate. The impairment loss is the excess of carrying amount over recoverable amount, allocated pro rata to the outlet's assets (no asset below its own recoverable amount where that can be determined). Measure an onerous contract provision for costs outside the lease liability at the lower of the cost of fulfilling (incremental costs plus an allocation of directly related costs) and the cost of exiting, net of any benefits still expected, discounted where material. Measure a restoration provision at the present value of the best estimate of the expenditure required, using a pre-tax discount rate reflecting current market assessments of the time value of money and the risks specific to the obligation; the discount unwinds through finance cost, and changes in estimated cash flows, timing or rate adjust both the provision and the related asset.

Disclose impairment losses (and any reversals) recognized on right-of-use assets and leasehold improvements, the events that led to them, whether recoverable amount is value in use or fair value less costs of disposal, and the discount rate used; for each class of provision (restoration/dilapidation, onerous non-lease contracts), a reconciliation from opening to closing balance showing additions, amounts used, unused amounts reversed and unwinding of the discount; the expected timing of the outflows; key assumptions and estimation uncertainty (trading forecasts, scope and cost of restoration works, discount rates); and contingent liabilities for possible obligations not provided for, with an estimate of financial effect where practicable.

• Recognizing an IAS 37 onerous lease provision for future rent on a lease already recognized under IFRS 16, which double counts the rent in the lease liability
• not testing the right-of-use asset for impairment until the outlet has physically closed
• deducting lease payments in value-in-use cash flows while leaving the lease liability out of the carrying amount tested (or the reverse), producing an inconsistent test
• ignoring unavoidable non-lease costs (service and maintenance contracts) that remain after part of an outlet is shut down
• ignoring dilapidation/reinstatement clauses until the lease is about to end instead of recognizing the obligation as it arises
• recognizing a provision for future operating losses as such
• not discounting long-dated restoration provisions, or failing to unwind the discount as a finance cost.