IFRS 16 Lease term explained

Last update 28/10/2019

IFRS 16 Lease term explained or the lease term includes the following items (IFRS 16 18):

non-cancellable period of a lease; IFRS 16 Lease term explained
periods covered by an option to extend the lease – if the lessee (customer) is reasonably certain to exercise that option; and
periods covered by an option to terminate the lease – if the lessee (customer) is reasonably certain not to exercise that option.

The lease term should not go beyond the ‘enforceable period’ which lasts up to a point when both parties have the right to terminate the lease without permission from the other party with no more than an insignificant penalty (IFRS 16 B34).

Legal framework in a given country plays an important role in assessing the lease term. Laws governing lease contracts may sometimes override contractual provisions, so careful assessment of rights and obligations of lessees and lessors is needed.

The lease term includes also any ‘rent-free’ periods (IFRS 16 B36). IFRS 16 Lease term explained

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Example 1 IFRS 16 Lease term explained

Analysis IFRS 16 Lease term explained

Example 2 IFRS 16 Lease term explained

IFRS 16 Lease term explained

Example 1 IFRS 16 Lease term explained

A lease contract starts on 1 January 20X1 and has the following features:

neither party to the contract can terminate the lease during the first 2 years
a customer (a lessee) can extend the contract for another 2 years and the supplier (a lessor) cannot refuse such an extension
if the customer exercises the option for another 2 years, neither party can terminate the lease during another 2 years
if the customer does not exercise the option for additional 2 years, the lease is still in force, but each party can terminate the lease with a 3-month notice period (when the notice is given after 1 year and 9 months, the lease term ends exactly after 2 years)

Analysis IFRS 16 Lease term explained

There is a non-cancellable term in this lease for both parties, the first two years (IFRS 16 B34 – B35). If the customer (lessee) is reasonably certain to exercise the option for extension the lease term is 4 years. Reasonably certain is most easily evidenced by historical business behaviour i.e. other leases that were also with an extension option that were extended. Otherwise the intention can also be documented by an appropriately authorised policy document for each individual lease (if deviations are common in the entity’s business/history) or a general policy document. The phrase ‘reasonably certain’, which is also used in IAS 17, is generally interpreted as a high threshold.

1 Jan 20×1

1 Jan 20×2

1 Jan 20×3

1 Jan 20×5

Non-cancellable term

Optional extension period under lessee’s control

Extension option period

Enforceable period

The legal framework in a given country plays an important role in assessing the lease term. Laws governing lease contracts may sometimes override contractual provisions, so careful assessment of rights and obligations of lessees and lessors is needed.

The lease term includes also any ‘rent-free’ periods (IFRS 16 B36).