Calculating lease reassessments and modifications under IFRS 16
In an IFRS 16 calculation, it is important to distinguish between reassessments and modifications to account for changes correctly.
Reassessments cover a change in the assessment of whether the lessee is reasonably certain to exercise (or not to exercise) an extension, termination or purchase option in the original contract, and changes in lease payments resulting from an index or a rate, or from amounts expected to be payable under a residual value guarantee (IFRS 16.39–43). A change in the lease term or in the assessment of a purchase option is remeasured using a revised discount rate (IFRS 16.40–41). A change in an index, a rate or a residual value guarantee is remeasured using an unchanged discount rate, unless the change in lease payments results from a change in floating interest rates; in that case, a revised discount rate is used (IFRS 16.42–43).
A reassessment of the original contract follows the terms and conditions of the original contract.
This differs in accounting terms from modifications. A modification is a change in the scope of a lease, or in the consideration for a lease, that was not part of the original terms and conditions, typically the result of renegotiating the original contract (IFRS 16, Appendix A).
Related article: What is IFRS 16?
Examples of lease modifications
- The scope increases by adding the right to use one or more underlying assets, or by extending the lease term.
- The scope decreases by terminating the right to use one or more underlying assets, or by shortening the lease term.
- The consideration changes because the lease payments are increased or reduced.
An increase in scope is accounted for as a separate lease if it adds the right to use one or more underlying assets and the consideration increases by an amount commensurate with the stand-alone price for the increase in scope (IFRS 16.44). Other modifications are accounted for by remeasuring the lease liability using a revised discount rate at the effective date of the modification (IFRS 16.45). A decrease in scope that does not follow from the terms of the original contract is a partial or full termination: the right-of-use asset is reduced, and any gain or loss is recognised in profit or loss (IFRS 16.46(a)).
Example 1 – decrease in scope: modification versus reassessment
A ten-year lease with quarterly lease payments of EUR 25,000, paid at the beginning of each quarter. The lessee has no right to terminate the lease. On 1 January of year 6, the parties agree to shorten the lease term so that it ends at the end of year 7, against a one-off payment of EUR 120,000 on 1 January of year 6. The discount rate is now assessed at 9% for the remaining lease term (originally 5%). Present values are calculated with a quarterly rate derived from the annual rate: (1 + annual rate)1/4 − 1.
| Date | Remaining quarters | Quarterly payment (EUR) | Termination payment, year 6 (EUR) | Annual rate | Present value (EUR) |
|---|---|---|---|---|---|
| 1 Jan, year 1 | 40 | 25,000 | 5% | 796,157 | |
| 1 Jan, year 6 | 8 | 25,000 | 120,000 | 9% | 305,700 |
In this example, there are two elements to account for:
- Decrease in the right-of-use asset and the lease liability for the partial termination (IFRS 16.46(a)). The lease term is shortened by three of the remaining five years, a 60% reduction in the remaining lease term and in the nominal lease payments. The right-of-use asset is reduced by the same 60%. The present value of the liability falls by a slightly smaller percentage, because the payments that disappear are the last ones.
- Remeasurement of the remaining lease payments and the termination payment using the revised discount rate (IFRS 16.45(c) and 16.46(b)). Before the modification, the lease liability on 1 January of year 6 is EUR 446,395, of which EUR 191,716 relates to the new remaining period of eight quarters, calculated at the original rate of 5%. The new lease liability at the incremental borrowing rate of 9% is EUR 305,700 (EUR 120,000 paid on 1 January of year 6 plus the present value of eight quarterly payments of EUR 25,000 in advance). The lease liability for the remaining two-year period therefore increases by EUR 113,983. The right-of-use asset is first reduced by 60%, i.e. EUR 238,847, and then increased by the same amount as the liability. The difference between the reduction in the liability (EUR 254,679) and the reduction in the asset (EUR 238,847) is a gain of EUR 15,831, recognised in profit or loss. The table shows the new liability, asset and profit or loss effect:
| EUR | 1 Jan, year 6, before the change | Of which remaining period (5%) | Partial termination | Remeasurement (9%) | New amount |
|---|---|---|---|---|---|
| Lease liability | 446,395 | 191,716 | −254,679 | 113,983 | 305,700 |
| Right-of-use asset | 398,078 | 159,231 | −238,847 | 113,983 | 273,215 |
| Gain (profit or loss) | 15,831 |
If the original lease had instead included an option to terminate the lease at the end of year 7 against a one-off payment of EUR 120,000 on 1 January of year 6, and the lessee had decided on 1 January of year 6 to exercise the option, this would not be a modification but a reassessment of the lease term (IFRS 16.20–21). There would then be only one element to account for: a reduction in the right-of-use asset and the lease liability for the changed assessment of the termination option. Because the lease term changes, the liability is remeasured using a revised discount rate (IFRS 16.40(a) and 16.41), here 9%, so the new lease liability is the same as in the example above. However, no gain or loss is recognised, and the right-of-use asset is adjusted by the same amount as the lease liability (IFRS 16.39):
| EUR | 1 Jan, year 6, before the change | Change | New amount |
|---|---|---|---|
| Lease liability | 446,395 | −140,695 | 305,700 |
| Right-of-use asset | 398,078 | −140,695 | 257,383 |
Example 2 – reassessment of an option and increase in scope
A five-year lease with quarterly lease payments of EUR 25,000, paid in advance. The underlying asset is available on 1 January of year 1 (the commencement date). The lease includes an option to extend it by five years. At the commencement date, the lessee was assessed as not reasonably certain to exercise the option. The discount rate is set at 5%. In June of year 4, the company gives notice that it will exercise the option, and at the same time the parties agree to increase the leased floor space, so that the quarterly payment increases from EUR 25,000 to EUR 32,000 from 1 July of year 4. The discount rate is now assessed at 6% for the remaining lease term.
In this case, there is both a reassessment of the exercise of the option and a modification (increased floor space). Both are remeasured using a revised discount rate (IFRS 16.40(a), 16.41 and 16.45(c)).
| Remaining quarters | Quarterly payment (EUR) | Rate | Lease liability (EUR) | Right-of-use asset (EUR) | |
|---|---|---|---|---|---|
| 1 Jan, year 1 | 20 | 25,000 | 5% | 446,395 | 446,395 |
| 1 Jul, year 4, before the change | 2 | 25,000 | 5% | 49,697 | 44,639 |
| New amount, 1 Jul, year 4 | 22 | 32,000 | 6% | 606,733 | 601,676 |
| Change, 1 Jul, year 4 | 557,036 | 557,036 |
The change in present value of EUR 557,036 is recognised as a credit to the lease liability and a debit to the right-of-use asset. For simplicity, the example measures it on 1 July of year 4; under IFRS 16, the effective date of the modification is the date when both parties agree to it, here in June of year 4. The additional floor space is made available on the same date, for the same remaining term and at the same discount rate as the extension. The result is therefore the same whether the increase in scope is accounted for as a separate lease (IFRS 16.44) or as part of the remeasurement (IFRS 16.45), and in practice it is not necessary to assess whether the increase is priced at its stand-alone price. Quarterly depreciation changes from EUR 22,320 to EUR 27,349.
If the additional floor space is not available until 1 January of year 5 and the increase is accounted for as a separate lease (IFRS 16.44), the lease liability and right-of-use asset for that space are recognised only when the space is made available, and its depreciation starts then. The change relating to the existing premises (the extension) is still recognised on 1 July of year 4. For an increase in scope that is not a separate lease, see the discussion below.
Example 3 – termination and move to new premises owned by the same lessor
As in Example 2 at the commencement date, but at the end of year 3 the business has grown and needs new premises. On 1 January of year 4, a new five-year lease is entered into with the same lessor for different premises (a new underlying asset). The rent is at its stand-alone price of EUR 50,000 per quarter. The previous lease is terminated from 1 January of year 4 without any particular compensation, and the business moves to the new premises. The discount rate is now assessed at 5.5%. This gives the following figures:
| Remaining quarters | Quarterly payment (EUR) | Rate | Lease liability (EUR) | Right-of-use asset (EUR) | Gain (EUR) | |
|---|---|---|---|---|---|---|
| 1 Jan, year 1 | 20 | 25,000 | 5% | 446,395 | 446,395 | |
| Remaining, 1 Jan, year 4, before the change | 8 | 25,000 | 5% | 191,716 | 178,558 | 13,158 |
| New lease, 1 Jan, year 4 | 20 | 50,000 | 5.5% | 883,219 | 883,219 |
In this case, the original lease liability and right-of-use asset are derecognised and a gain is recognised on 1 January of year 4 (full termination, IFRS 16.46(a)). The new lease is recognised as a separate lease from the same date. If the agreement had been made earlier, the measurement and the gain would also have been recognised at that earlier date, but the remaining lease liability and right-of-use asset from the IFRS 16 calculation would have continued to be recognised until 1 January of year 4. The new premises would be recognised only from 1 January of year 4. See the discussion below.
When is a lease modification accounted for?
A modification is accounted for from the effective date of the modification: the date when both parties agree to a lease modification (IFRS 16, Appendix A).
In some cases, the modification is agreed (the effective date of the modification) before the change actually takes effect (the commencement date).
If an increase in scope (for example additional premises) is accounted for as a separate lease (IFRS 16.44), it is recognised at the commencement date of that lease. If it is not a separate lease, we consider it acceptable to recognise the part allocated to the new lease component at its commencement date. The commencement date is the date on which a lessor makes an underlying asset available for use by a lessee.
Note that IFRS 16.59(b)(iv) requires disclosure of leases not yet commenced to which the lessee is committed.
The examples above show that changes to leases can involve fairly complex calculations. It is important that the system you use can record and calculate them correctly, and that users understand how different changes are accounted for and enter the data correctly when required.
