exercised only if one or more conditions are met), and the likelihood that those
conditions will exist. [IFRS 16.B37].
The longer the period from commencement of the lease to the exercise date of an option,
the more difficult it will be, in certain cases, to determine whether the exercise of the
option is reasonably certain. The difficulty arises from several factors. For example, a
lessee’s estimates of its future needs for the leased asset become less precise the further
into the future the forecast goes. Also, the future fair value of certain assets such as those
involving technology is more difficult to predict than the future fair value of a relatively
stable asset, such as a fully leased commercial office building located in a prime area.
The further into the future that the option exercise date is, the lower the option price
must be in relation to the estimated future fair value to conclude that the lessee is
reasonably certain to exercise the option. For example, the difference between the
option purchase price and the estimated future fair value of an asset that is subject to
significant changes in value also should be greater than would be the case for an asset
with a relatively stable value.
An artificially short lease term (e.g. a lease of a corporate headquarters, distribution
facility, manufacturing plant or other key property with a four-year lease term), may
effectively create a significant economic incentive for the lessee to exercise a purchase
or renewal option. This may be evidenced by the significance of the underlying asset to
the lessee’s continuing operations and whether, absent the option, the lessee would
have entered into such a lease.
Similarly, the significance of the underlying asset to the lessee’s operations may affect a
lessee’s decisions about whether it is reasonably certain to exercise a purchase or
renewal option. For example, a company that leases a specialised facility (e.g.
manufacturing plant, distribution facility, corporate headquarters) and does not exercise
a purchase or renewal option would face a significant economic penalty if an alternative
facility is not readily available. This would potentially have an adverse effect on the
company while it searched for a replacement asset.
An option to extend or terminate a lease may be combined with one or more other
contractual features (for example, a residual value guarantee) such that the lessee
guarantees the lessor a minimum or fixed cash return that is substantially the same
Leases (IFRS 16) 1717
regardless of whether the option is exercised. In such cases, and notwithstanding the
guidance on in-substance fixed payments (see 4.5.1 below), an entity assumes that the
lessee is reasonably certain to exercise the option to extend the lease, or not to exercise
the option to terminate the lease. [IFRS 16.B38].
The shorter the non-cancellable period of a lease, the more likely a lessee is to exercise
an option to extend the lease or not to exercise an option to terminate the lease. This is
because the costs associated with obtaining a replacement asset are likely to be
proportionately higher the shorter the non-cancellable period. [IFRS 16.B39].
A lessee’s past practice regarding the period over which it has typically used particular
types of assets (whether leased or owned), and its economic reasons for doing so, may
provide information that is helpful in assessing whether the lessee is reasonably certain
to exercise, or not to exercise, an option. For example, if a lessee has typically used
particular types of assets for a particular period of time or if the lessee has a practice of
frequently exercising options on leases of particular types of underlying assets, the
lessee considers the economic reasons for that past practice in assessing whether it is
reasonably certain to exercise an option on leases of those assets. [IFRS 16.B40].
A lessee may enter into a lease contract for non-consecutive periods. This is seen in the
retail industry when retailers enter into contracts with shopping centres to lease the same
retail space for certain non-consecutive months of the year (e.g. during an annual holiday
period). Similar arrangements also exist when sports teams lease a sports stadium for
particular non-consecutive days of the year. These arrangements will usually meet the
definition of a lease because during the agreed period of use, the customer controls the
right to use the underlying asset. In these arrangements, the lease term is the aggregate of
the non-consecutive periods, as shown in Example 24.11, Scenario C.
Example 24.11: Determining the lease term
Scenario A
Assume that Entity P enters into a lease for equipment that includes a non-cancellable term of four years and
a two-year fixed-priced renewal option with future lease payments that are intended to approximate market
rates at lease inception. There are no termination penalties or other factors indicating that Entity P is
reasonably certain to exercise the renewal option.
Analysis: At the lease commencement date, the lease term is four years.
Scenario B
Assume that Entity Q enters into a lease for a building that includes a non-cancellable term of four years and
a two-year, market-priced renewal option. Before it takes possession of the building, Entity Q pays for
leasehold improvements. The leasehold improvements are expected to have significant value at the end of
four years, and that value can only be realised through continued occupancy of the leased property.
Analysis: At lease commencement, Entity Q determines that it is reasonably certain to exercise the renewal option
because it would suffer a significant economic penalty if it abandoned the leasehold improvements at the end of
the initial non-cancellable period. At lease commencement, Entity Q concludes that the lease term is six years.
Scenario C
Assume that Entity R enters into a lease for an identified retail space in a shopping centre. The retail space
will be available to Entity R for only the months of October, November and December during a non-
cancellable term of five years. The lessor agrees to provide the same retail space for each of the five years.
Analysis: At the lease commencement date, the lease term is fifteen months (three months per year over the
5 annual periods specified in the contract).
1718 Chapter 24
4.4.1 Cancellable
leases
In determining the lease term and assessing the length of the non-cancellable period of
a lease, an entity applies the definition of a contract and determines the period for which
the contract is enforceable. A lease is no longer enforceable when the lessee and the
lessor each has the right to terminate the lease without permission from the other party
with no more than an insignificant penalty. [IFRS 16.B34].
The question arises as to whether penalty should be interpreted to include only the
contractual amount payable by one party to the other if the termination option is
exercised (i.e. the narrow interpretation) or whether significant economic disincentives
should also be considered a penalty (i.e. the wide interpretation). With respect to the
determination of the lease term, IFRS 16 requires an entity to consider all relevant facts
and circumstances that create an
economic incentive for the lessee to exercise, or not
to exercise, the option (see 4.4 above) and thus suggests that all aspects of termination
penalties, whether contractual or financial in nature or not, should be considered.
Although the guidance may not directly apply in this situation as the lessee is unable to
exercise the option to renew the lease without the approval of the lessor, we believe,
by analogy, it is appropriate to evaluate the existence of any significant economic
disincentives taking into account all facts and circumstances.
Any non-cancellable periods (by the lessee and lessor) in contracts that meet the
definition of a lease are considered part of the lease term. IFRS 16 further provides that,
if only a lessee has the right to terminate a lease, that right is considered to be an option
to terminate the lease available to the lessee that an entity considers when determining
the lease term. If only a lessor has the right to terminate a lease, the non-cancellable
period of the lease includes the period covered by the option to terminate the lease.
[IFRS 16.B35].
In many jurisdictions, property leases are subject to local property laws in addition to
the contractual terms of the lease arrangement. That is, local laws and regulations may
give the lessee legal renewal options not stated in the lease contract. Examples of where
the local law may provide lessee’s such rights include airport terminal and retail
shopping space. When assessing the lease term, entities need to consider whether local
laws and regulations create enforceable rights and obligations that need to be included
in the evaluation of the lease term.
IFRS 16 also applies to contracts that are referred to as ‘cancellable,’ ‘month-to-month,’
‘at-will,’ ‘evergreen,’ ‘perpetual’ or ‘rolling’ if they create enforceable rights and
obligations. These types of lease generally allow for the contract to continue beyond a
non-cancellable period until one party gives notice to terminate the contract (e.g. the
contract will roll monthly until the lessee or the lessor elect to terminate the contract).
If both the lessee and the lessor can terminate the contract without more than an
insignificant penalty at any time at or after the end of the non-cancellable term, then
there are no enforceable rights and obligations beyond the non-cancellable term (i.e.
the lease term is limited to the non-cancellable term). However, if the lessee holds a
renewal option, there may be other factors to consider to determine whether the lessee
is reasonably certain to extend the lease, including economic disincentives discussed in
section 4.4 above.
Leases (IFRS 16) 1719
Example 24.12: Cancellable leases
A lease contract has an initial non-cancellable period of one year and an extension for an additional year if
both the lessee and the lessor agree. There is no penalty for either party if they do not agree to extend for the
additional year. The initial one-year non-cancellable period meets the definition of a contract because it
creates enforceable rights and obligations. However, the one-year extension period does not meet the
definition of a contract because both the lessee and the lessor could unilaterally elect to not extend the
arrangement without a more than insignificant penalty. That is, at lease commencement, neither party has
enforceable rights and obligations beyond the initial non-cancellable period.
4.4.2
Reassessment of lease term and purchase options – lessees
After lease commencement, IFRS 16 requires lessees to monitor leases for significant
changes that could trigger a change in the lease term. A lessee reassesses whether it is
reasonably certain to exercise an extension option, or not to exercise a termination
option, upon the occurrence of either a significant event or a significant change in
circumstances that:
(a) is within the control of the lessee; and
(b) affects whether the lessee is reasonably certain to exercise an option not
previously included in its determination of the lease term, or not to exercise an
option previously included in its determination of the lease term. [IFRS 16.20].
Examples of significant events or changes in circumstances that would trigger a
reassessment include:
(a) significant leasehold improvements not anticipated at the commencement date
that are expected to have significant economic benefit for the lessee when the
option to extend or terminate the lease, or to purchase the underlying asset,
becomes exercisable;
(b) a significant modification to, or customisation of, the underlying asset that was not
anticipated at the commencement date;
(c) the inception of a sublease of the underlying asset for a period beyond the end of
the previously determined lease term; and
(d) a business decision of the lessee that is directly relevant to exercising, or not
exercising, an option (for example, a decision to extend the lease of a
complementary asset, to dispose of an alternative asset or to dispose of a business
unit within which the right-of-use asset is employed). [IFRS 16.B41].
An entity revises the lease term if there is a change in the non-cancellable period of a
lease. For example, the non-cancellable period of a lease will change if:
(a) the lessee exercises an option not previously included in the entity’s determination
of the lease term;
(b) the lessee does not exercise an option previously included in the entity’s
determination of the lease term;
(c) an event occurs that contractually obliges the lessee to exercise an option not
previously included in the entity’s determination of the lease term; or
(d) an event occurs that contractually prohibits the lessee from exercising an option
previously included in the entity’s determination of the lease term. [IFRS 16.21].
1720 Chapter 24
As a lessee is required to reassess the lease term upon the occurrence of either a
significant event or a significant change in circumstances that is within the control of
the lessee, the revision of the lease term often happens before the actual exercise of the
option in these circumstances. Additionally, if the reassessment of lease term or the
exercise of a purchase option results in a change, lessees would remeasure the lease
liability, using revised inputs (e.g. discount rate) at the reassessment date, and would
adjust the right-of-use asset. However, if the right-of-use asset is reduced to zero, a
lessee would recognise any remaining amount in profit or loss. See 4.5.9 below.
4.4.3
Reassessment of lease term and purchase options – lessors
IFRS 16 requires a lessor to revise the lease term to account for a lessee’s exercise of an
option to extend or terminate the lease or purchase the underlying asset, when exercise
of such options was not already included in the lease term.
4.5 Lease
payments
Lease payments are payments made by a lessee to a lessor relating to the right to use an
underlying asset during the lease term, comprising the following:
(a) fixed payments (including in-substance fixed payments), less any lease incentives;
(b) variable lease payments that depend on an index or a rate;
(c) th
e exercise price of a purchase option if the lessee is reasonably certain to
exercise that option; and
(d) payments of penalties for terminating the lease, if the lease term reflects the lessee
exercising an option to terminate the lease.
For the lessee, lease payments also include amounts expected to be payable by the lessee
under residual value guarantees. Lease payments do not include payments allocated to
non-lease components of a contract, unless the lessee elects to combine non-lease
components with a lease component and to account for them as a single lease component.
For the lessor, lease payments also include any residual value guarantees provided to
the lessor by the lessee, a party related to the lessee or a third party unrelated to the
lessor that is financially capable of discharging the obligations under the guarantee.
Lease payments do not include payments allocated to non-lease components.
[IFRS 16 Appendix A].
4.5.1
In-substance fixed lease payments
Lease payments include any in-substance fixed lease payments. In-substance fixed lease
payments are payments that may, in form, contain variability but that, in substance, are
unavoidable. In-substance fixed lease payments exist, for example, if:
(a) payments are structured as variable lease payments, but there is no genuine
variability in those payments. Those payments contain variable clauses that do not
have real economic substance. Examples of those types of payments include:
(i) payments that must be made only if an asset is proven to be capable of
operating during the lease, or only if an event occurs that has no genuine
possibility of not occurring; or
Leases (IFRS 16) 1721
(ii) payments that are initially structured as variable lease payments linked to the
use of the underlying asset but for which the variability will be resolved at
some point after the commencement date so that the payments become fixed
for the remainder of the lease term. Those payments become in-substance
fixed payments when the variability is resolved;
(b) there is more than one set of payments that a lessee could make, but only one of
those sets of payments is realistic. In this case, an entity considers the realistic set
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 339
