Lease Modifications (IFRS 16)

Last updated: 22 December 2019

A lease modification is a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease (IFRS 16.Appendix A). Examples of lease modifications are adding or terminating the right to use one or more underlying assets or extending or shortening the contractual lease term. When a lease modification occurs, it is accounted for either as a separate lease or adjustment to an existing lease.

Lease modification as a separate lease

A lessee (customer) accounts for a lease modification as a separate lease if both the criteria are met (IFRS 16.44):

1. the modification increases the scope of the lease by adding the right to use one or more underlying assets; and
2. the consideration for the lease increases by an amount commensurate with the stand-alone price for the increase in scope and any appropriate adjustments to that stand-alone price to reflect the circumstances of the particular contract.

When a lease modification is treated as a separate lease, the original right-for-use asset remains unaffected. See also Example 15 accompanying IFRS 16.

Lease modification not accounted for as a separate lease

The approach to lease modification not accounted for as a separate lease

When a lease modification is not accounted for as a separate lease, a lessee (customer) (IFRS 16.45):

1. allocates the consideration in the modified contract as when separating components of a contract,
2. determines the lease term of the modified lease,
3. remeasures the lease liability by discounting the revised lease payments using a revised discount rate.

The above accounting is made at the effective date of the lease modification, which is the date when both parties agree to a lease modification.

Decrease in the scope of a lease

When a lease modification decreases the scope of a lease (IFRS 16.46(a):

• the right-of-use asset and lease liability are decreased to reflect partial of full termination of the lease
• any gain or loss resulting from the above-mentioned derecognition is immediately recognised in P/L.

Example: Lease modification – decrease in scope

Entity A enters into a 10-year lease for a 2,500 sq meters of office space. The annual lease payments are $50,000 payable at the end of each year. The commencement date for the lease is 20X1-01-01 and the discount rate is 6%.

All calculations presented in this example are available for download in an excel file. You can scroll tables presented below horizontally if they don’t fit your screen.

Future payments for the lease are listed in the table below. For each payment, the discount factor is calculated in order to determine the total present value of the lease liability. As there were no payments at the commencement of the lease, lease liability and the right-of-use asset are equal at initial recognition and amount to $368,004 as shown below.

Calculation of lease liability and right-of-use asset:

The schedules for accounting in subsequent years for the lease liability and right-of-use asset are presented below.

As in previous examples, lease liability increases every year due to unwinding of discount (charged as finance costs in P/L) and decreases with each payment made:

And the carrying amount of the right-of-use asset decreases with depreciation charged each year:

Let’s now assume that a lease modification is made on 1 January 20X6. The scope of the lease decreases by 50% so that Entity A leases only 2,500 sq m out of original 5,000 sq m. The annual payment decreases as well from $50,000 to $30,000. The discount rate is revised to 5% at the modification date. Entity A calculates a gain in P/L as follows:

$184,002: Right-of-use asset before modification
Scope modified by: 50% (2,500 sq m out of original 5,000 sq m)
$92,001: Decrease of right-of-use asset by 50%
$92,001: Right-of-use asset after scope decrease
$210,618: Lease liability before modification
Scope modified by: 50% (2,500 sq m out of original 5,000 sq m)
$105,309: Decrease of liability by 50%
$105,309: Liability after scope decrease

As a result of the above calculations, Entity A recognises $13,308 ($105,309 – $92,001) as a gain on the termination of the lease under old terms (immediate recognition in P/L).

Reminder: all calculations for this example are available in the excel file.

At the modification date, Entity A calculates lease liability corresponding to annual payments of $30,000 and revised discount rate of 5%:

Accounting entries at the lease modification date (1 January 20X6) made by Entity A are as follows:

Note: this example is based on illustrative example 17 accompanying IFRS 16.

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Example: lease modification – both increase and decrease in scope

Entity A enters into a 10-year lease for a 2,000 sq meters of office space. The annual lease payments are $100,000 payable at the end of each year. The commencement date for this lease is 20X1-01-01 and the discount rate is 6%.

All calculations presented in this example are available for download in an excel file.

Lease liability and the right-of-use asset are equal at initial recognition and amount to $736,009 as shown below.

The schedules for accounting in subsequent years for the lease liability and right-of-use asset are presented below.

Lease liability:

Right-of-use asset:

Let’s assume now that a lease modification is made on 1 January 20X6 as follows:

• the scope is increased by additional 1,500 sq m
• the lease term is shortened from 10 to 8 years
• annual payments are increased to $150,000

The revised discount rate at the lease modification date is 7%.

Entity A determines that the increase in scope of the lease does not meet the criteria set out in paragraph IFRS 16.44 and therefore the increase in scope is not accounted for as a separate lease.

At the modification date, as a first step, Entity A calculates gain on the termination of the lease of 2,000 sq metres for years 9 and 10 as follows:

$368,004: Right-of-use asset before modification
Modified (remaining) scope: 60% (3 out of 5 remaining years)
$147,202: Decrease of right-of-use asset by 40%
$220,803: Right-of-use asset after scope decrease (remaining 60%)
$421,236: Liability before modification
$267,301: Remaining liability relating to modified scope (at original discount rate)
$153,935: Decrease of liability

As a result, Entity A recognises $6,733 ($153,935 – $147,202) as a gain on the termination of the lease under old terms (immediate recognition in P/L).

Reminder: all calculations for this example are available in the excel file.

Next, Entity A calculates the lease liability and right-of-use asset relating to the additional 1,500 sq m at $131,215.8 by discounting the additional annual payments of $50,000 at 7%:

This amount is added to the value of the right-of-use asset (all accounting entries are summarised at the end of this example).

As a final step, Entity A calculates the impact of the revised discount rate on the lease liability part that reflects the annual payments of $100,000 for years 20X6-20X8. Liability discounted at original discount rate of 6% ($267,301.2) is compared to the amount discounted at 7% ($262,431.6). The difference of $4,869.6 is deducted from the right-of-use asset and lease liability.

In summary, the following accounting entries are made by Entity A at the modification date:

1/ Gain on the termination of the lease of 2,000 sq metres for years 9 and 10 -> immediate recognition in P/L:

2/ Impact of revised discount rate for years 6-8 on the lease of 2,000 sq metres:

3/ Impact of increased leased space (additional 1,500 sq metres):

Accounting for the lease liability and the right-of-use asset in the years following the modification will be as follows:

Lease liability:

Right-of-use asset:

Note: this example is based on illustrative example 18 accompanying IFRS 16.

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Lease modifications that do not decrease the scope of a lease

When a lease modification does not decrease the scope of a lease, the changes in lease liability have a corresponding impact on the right-of-use asset without any one-off recognition in P/L (IFRS 16.46(b)).

For lease modifications that increase the scope of a lease, the adjustment to the carrying amount of the right-of-use asset effectively represents the cost of the additional right of use acquired as a result of the modification. For lease modifications that change the consideration paid for a lease, the adjustment to the carrying amount of the right-of-use asset effectively represents a change in the cost of the right-of-use asset as a result of the modification. The use of a revised discount rate in remeasuring the lease liability reflects that, in modifying the lease, there is a change in the interest rate implicit in the lease (IFRS 16.BC203).

See also Examples 16 and 19 accompanying IFRS 16 and an excel example below based on Example 19 from IFRS 16.

Example: lease modification – change in consideration only

In this example, Entity A enters into a 10-year lease for office space, the starting point, assumptions and calculations for initial recognition of a lease liability and right-of-use asset at $736,009 are the same as in this example. All calculations are also available for download in an excel file. You can scroll tables presented below horizontally if they don’t fit your screen.

Let’s now assume that a lease modification is made on 1 January 20X6 and both parties agree to lower annual lease payments amounting to $95,000. The lease term and lease scope remain unchanged. Entity A determines that the discount rate at the modification date increases to 7%.

Entity A calculates new present value of lease liability taking into account updated amounts of lease payments and revised discount rate:

The amount calculated above is obviously lower that the lease liability before the modification ($421,236.4), the difference is accounted for as follows:

Accounting for the lease liability and the right-of-use asset in the years following the modification will be as follows:

Lease liability:

Right-of-use asset:

Note: this example is based on illustrative example 19 accompanying IFRS 16.

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More about IFRS 16

See other pages relating to IFRS 16: