(b) reducing the carrying amount to reflect the lease payments made; and
(c) remeasuring the carrying amount to reflect any reassessment or lease modifications
specified, or to reflect revised in-substance fixed lease payments. [IFRS 16.36].
Interest on the lease liability in each period during the lease term is the amount that
produces a constant periodic rate of interest on the remaining balance of the lease liability.
The periodic rate of interest is the discount rate described at commencement, unless a
reassessment requiring a change in the discount rate has been triggered. [IFRS 16.37].
5.3.3 Expense
recognition
After the commencement date, the lessee recognises depreciation and impairment of
the right-of-use asset in profit or loss, unless depreciation is permitted to be capitalised
(e.g. to inventory) under other IFRS (or the lessee applies the fair value model described
in at 5.3.1.B above).
A lessee also recognises in profit or loss, unless the costs are included in the carrying
amount of another asset applying other IFRS, both:
(a) interest on the lease liability; and
(b) variable lease payments not included in the measurement of the lease liability in the
period in which the event or condition that triggers those payments occurs. [IFRS 16.38].
When a lessee depreciates the right-of-use asset on a straight-line basis, the total
periodic expense (i.e. the sum of interest and depreciation expense) is generally higher
in the early periods and lower in the later periods. Because a constant interest rate is
applied to the lease liability, the interest expense decreases as cash payments are made
during the lease term and the lease liability decreases. Therefore, more interest expense
is incurred in the early periods and less in the later periods. This trend in the interest
1732 Chapter 24
expense, combined with straight-line depreciation of the right-of-use asset, results in a
front-loaded expense recognition pattern. This expense pattern is consistent with the
subsequent measurement of finance leases under IAS 17.
If a lessee determines that a right-of-use asset is impaired, it recognises an impairment
loss and measures the right-of-use asset at its carrying amount immediately after the
impairment. A lessee subsequently depreciates, generally on a straight-line basis, the
right-of-use asset from the date of the impairment to the earlier of the end of the useful
life of the right-of-use asset or the end of the lease term. However, the depreciation
period is the remaining useful life of the underlying asset if the lessee is reasonably
certain to exercise an option to purchase the underlying asset or if the lease transfers
ownership of the underlying asset to the lessee by the end of the lease term. See 5.6.1
below for additional discussion of impairment of right-of-use assets.
Example 24.17: Lessee accounting
Entity H (lessee) enters into a three-year lease of equipment. Entity H agrees to make the following annual
payments at the end of each year: CU10,000 in year one, CU12,000 in year two and CU14,000 in year three.
For simplicity, there are no other elements to the lease payments (e.g. purchase options, lease incentives from
the lessor, initial direct costs). The initial measurement of the right-of-use asset and lease liability is
CU33,000 (present value of lease payments using a discount rate of approximately 4.235%). Entity H uses
its incremental borrowing rate because the rate implicit in the lease cannot be readily determined. Entity H
depreciates the right-of-use asset on a straight-line basis over the lease term.
Analysis: At lease commencement, Entity H would recognise the lease-related asset and liability:
Right-of-use asset
CU33,000
Lease liability
CU33,000
To initially recognise the lease-related asset and liability
The following journal entries would be recorded in the first year:
Interest expense
CU1,398
Lease liability
CU1,398
To record interest expense and accrete the lease liability using the interest
method (CU33,000 × 4.235%)
Depreciation expense
CU11,000
Right-of-use asset
CU11,000
To record depreciation expense on the right-of-use asset (CU33,000 ÷ 3 years)
Lease liability
CU10,000
Cash
CU10,000
A summary of the lease contract’s accounting (assuming no changes due to reassessment) is as follows:
Initial
Year 1
Year 2
Year 3
CU
CU
CU
CU
Cash lease payments
10,000
12,000
14,000
Lease expense recognised
Interest
expense
1,398
1,033
569
Depreciation
expense
11,000 11,000 11,000
Total periodic expense
12,398
12,033
11,569
Statement of financial position
Right-of-use asset
33,000
22,000
11,000
–
Lease
liability
(33,000) (24,398) (13,431)
–
Leases (IFRS 16) 1733
5.4
Remeasurement of lease liabilities
After the commencement date, a lessee remeasures the lease liability to reflect changes
to the lease payments. A lessee recognises the amount of the remeasurement of the lease
liability as an adjustment to the right-of-use asset. However, if the carrying amount of
the right-of-use asset is reduced to zero and there is a further reduction in the
measurement of the lease liability, a lessee recognises any remaining amount of the
remeasurement in profit or loss. [IFRS 16.39].
A lessee remeasures the lease liability by discounting the revised lease payments using
a revised discount rate, if:
(a) there is a change in the lease term. A lessee determines the revised lease payments
on the basis of the revised lease term; or
(b) there is a change in the assessment of an option to purchase the underlying asset,
assessed considering the events and circumstances in the context of a purchase
option. A lessee determines the revised lease payments to reflect the change in
amounts payable under the purchase option. [IFRS 16.40].
The lessee determines the revised discount rate as the interest rate implicit in the lease
for the remainder of the lease term, if that rate can be readily determined, or the lessee’s
incremental borrowing rate at the date of reassessment, if the interest rate implicit in
the lease cannot be readily determined. [IFRS 16.41].
A lessee remeasures the lease liability by discounting the revised lease payments, if:
(a) there is a change in the amounts expected to be payable under a residual value
guarantee. A lessee determines the revised lease payments to reflect the change in
amounts expected to be payable under the residual value guarantee;
(b) there is a change in future lease payments resulting from a change in an index or a
rate used to determine those payments, including
for example a change to reflect
changes in market rental rates following a market rent review. The lessee
remeasures the lease liability to reflect those revised lease payments only when
there is a change in the cash flows (i.e. when the adjustment to the lease payments
takes effect). A lessee determines the revised lease payments for the remainder of
the lease term based on the revised contractual payments. [IFRS 16.42].
In applying the paragraph above, a lessee uses an unchanged discount rate, unless the
change in lease payments results from a change in floating interest rates. In that case, the
lessee uses a revised discount rate that reflects changes in the interest rate. [IFRS 16.43].
When a lease includes a market rate adjustment (a market rent review), the negotiations
between the lessee and the lessor may take some time to complete (the negotiation
period). For example, consider a 10 year lease that has a market rate adjustment that
applies from the end of year 5. The market rent review negotiations begin during year 5
but are not completed until later in year 6. During year 6, while the negotiation is ongoing,
the lessee is required to pay the original contractual lease payments. At the conclusion of
the negotiation period (i.e. upon a final determination of the lease payments for year 6
until year 10), the new lease payments apply retrospectively from the beginning of year 6.
In this example, the lessee does not adjust the lease payments at the beginning of year 6
for the expected increase in rent. Rather, any adjustment is recognised as an adjustment
1734 Chapter 24
to lease payments when the market rent review is finalised and the change in
contractual cash flows takes effect.
5.5 Lease
modifications
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 (for example, adding
or terminating the right to use one or more underlying assets, or extending or shortening
the contractual lease term). [IFRS 16 Appendix A].
If a lease is modified, the modified contract is evaluated to determine whether it is or contains
a lease (see 3.1 above). If a lease continues to exist, the lease modification can result in:
• a separate lease (see 5.5.1 below); or
• a change in the accounting for the existing lease (i.e. not a separate lease)
(see 5.5.2 below).
The exercise of an existing purchase or renewal option or a change in the assessment
of whether such options are reasonably certain to be exercised are not lease
modifications but can result in the remeasurement of lease liabilities and right-of-use
assets (see 5.4 above).
5.5.1
Determining whether a lease modification results in a separate lease
A lessee accounts for a lease modification as a separate lease when both of the following
conditions are met:
• the modification increases the scope of the lease by adding the right to use one or
more underlying assets; and
• the consideration for the lease increases commensurate with the stand-alone price
for the increase in scope and any adjustments to that stand-alone price reflect the
circumstances of the particular contract. [IFRS 16.44].
If both of these conditions are met, the lease modification results in two separate leases,
the unmodified original lease and a separate new lease. Lessees account for the separate
contract that contains a lease in the same manner as other new leases. If either of the
conditions are not met, the modified lease is not accounted for as a separate lease
(see 5.5.2 below).
5.5.2
Lessee accounting for a modification that does not result in a
separate lease
For a lease modification that is not accounted for as a separate lease, at the effective
date of the lease modification the lessee:
(a) allocates the consideration in the modified contract;
(b) determines the lease term of the modified lease; and
(c) remeasures the lease liability by discounting the revised lease payments using a revised
discount rate. The revised discount rate is determined as the interest rate implicit in
the lease for the remainder of the lease term, if that rate can be readily determined, or
the lessee’s incremental borrowing rate at the effective date of the modification, if the
interest rate implicit in the lease cannot be readily determined. [IFRS 16.45].
Leases (IFRS 16) 1735
For a lease modification that is not accounted for as a separate lease, the lessee accounts
for the remeasurement of the lease liability by:
(a) decreasing the carrying amount of the right-of-use asset to reflect the partial or full
termination of the lease for lease modifications that decrease the scope of the
lease. The lessee recognises in profit or loss any gain or loss relating to the partial
or full termination of the lease; or
(b) making a corresponding adjustment to the right-of-use asset for all other lease
modifications. [IFRS 16.46].
IFRS 16 contains a number of illustrative examples on modifications, which are
reproduced below. [IFRS 16.IE7].
Example 24.18: Lease modifications (IFRS 16 Illustrative Examples 15 to 19)
IFRS 16 Example 15 – Modification that is a separate lease
Lessee enters into a 10-year lease for 2,000 square metres of office space.
At the beginning of Year 6, Lessee and Lessor agree to amend the original lease for the remaining five years
to include an additional 3,000 square metres of office space in the same building. The additional space is
made available for use by Lessee at the end of the second quarter of Year 6. The increase in total consideration
for the lease is commensurate with the current market rate for the new 3,000 square metres of office space,
adjusted for the discount that Lessee receives reflecting that Lessor does not incur costs that it would
otherwise have incurred if leasing the same space to a new tenant (for example, marketing costs).
Lessee accounts for the modification as a separate lease, separate from the original 10-year lease. This is
because the modification grants Lessee an additional right to use an underlying asset, and the increase in
consideration for the lease is commensurate with the stand-alone price of the additional right-of-use adjusted
to reflect the circumstances of the contract. In this example, the additional underlying asset is the new 3,000
square metres of office space. Accordingly, at the commencement date of the new lease (at the end of the
second quarter of Year 6), Lessee recognises a right-of-use asset and a lease liability relating to the lease of
the additional 3,000 square metres of office space. Lessee does not make any adjustments to the accounting
for the original lease of 2,000 square metres of office space as a result of this modification.
IFRS 16 Example 16 – Modification that increases the scope of the lease by extending the contractual lease term
Lessee enters into a 10-year lease for 5,000 square metres of office space. The annual lease payments are
CU100,000 payable at the end of each year. The interest rate implicit in the lease cannot be readily determined.
Lessee’s incremental borrowing rate at the commencement date is 6 per cent per annum. At the beginning of
Year 7, Le
ssee and Lessor agree to amend the original lease by extending the contractual lease term by four
years. The annual lease payments are unchanged (i.e. CU100,000 payable at the end of each year from Year 7
to Year 14). Lessee’s incremental borrowing rate at the beginning of Year 7 is 7 per cent per annum.
At the effective date of the modification (at the beginning of Year 7), Lessee remeasures the lease liability
based on: (a) an eight-year remaining lease term, (b) annual payments of CU100,000 and (c) Lessee’s
incremental borrowing rate of 7 per cent per annum. The modified lease liability equals CU597,130. The
lease liability immediately before the modification (including the recognition of the interest expense until the
end of Year 6) is CU346,511. Lessee recognises the difference between the carrying amount of the modified
lease liability and the carrying amount of the lease liability immediately before the modification (CU250,619)
as an adjustment to the right-of-use asset.
IFRS 16 Example 17 – Modification that decreases the scope of the lease
Lessee enters into a 10-year lease for 5,000 square metres of office space. The annual lease payments are
CU50,000 payable at the end of each year. The interest rate implicit in the lease cannot be readily determined.
Lessee’s incremental borrowing rate at the commencement date is 6 per cent per annum. At the beginning of Year
6, Lessee and Lessor agree to amend the original lease to reduce the space to only 2,500 square metres of the
original space starting from the end of the first quarter of Year 6. The annual fixed lease payments (from Year 6
to Year 10) are CU30,000. Lessee’s incremental borrowing rate at the beginning of Year 6 is 5 per cent per annum.
1736 Chapter 24
At the effective date of the modification (at the beginning of Year 6), Lessee remeasures the lease liability
based on: (a) a five-year remaining lease term, (b) annual payments of CU30,000 and (c) Lessee’s incremental
borrowing rate of 5 per cent per annum. This equals CU129,884.
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 342
