IFRS 16 Lease Modifications and Remeasurement Explained

Understand Lease Modifications and Remeasurement

Key rules to remember

Separate lease test (lessee)

Separate lease = extra right of use of underlying asset(s) AND price increase ≈ standalone price of the extra scope

Both conditions must be met. The standalone price may be adjusted for the circumstances of the contract. An extension of term alone does not add an asset, so it is not a separate lease.

Modification that is not a separate lease: liability

New liability = PV of revised remaining payments, discounted at the revised rate at the modification date

Use the rate implicit in the lease for the remaining term if it can be readily determined. Otherwise use the lessee's incremental borrowing rate at the modification date. Also reallocate the consideration and determine the new lease term.

Decrease in scope (partial or full termination)

Reduce ROU asset in proportion to the scope decrease. Gain or loss = reduction in liability − reduction in ROU asset

Recognise the gain or loss in profit or loss. Any remaining difference from remeasuring the liability is adjusted against the ROU asset.

Other modifications (not a separate lease, no scope decrease)

ROU asset adjusted by the full remeasurement of the lease liability

Dr ROU asset and Cr lease liability if the liability rises. Do the reverse if it falls.

Reassessment of lease term or purchase option

Remeasure liability using a revised discount rate at the date of reassessment. Adjust ROU asset by the same amount

If the ROU asset is reduced to zero, take any further reduction to profit or loss.

Change in residual value guarantee or in an index or rate

Remeasure liability using the original discount rate. Adjust ROU asset

Exception: if the change comes from a floating interest rate, use a revised discount rate that reflects the rate change.

COVID-19 rent concession expedient (lessee)

Concession is not assessed as a modification if: direct result of COVID-19, consideration is substantially the same or less, reduction affects only payments due on or before 30 June 2022, no other substantive change

Account for the concession as a negative variable lease payment. Derecognise the part of the liability that is forgiven and credit profit or loss. It is optional and applied consistently to similar leases.

How to solve Lease Modifications and Remeasurement questions

1. 1Identify what changed. Is it a contract change agreed by both sides (modification), or a change in your own estimate or an index (reassessment)?
2. 2If it is a modification, note the effective date. This is the date both parties agree to it. That is the date you remeasure at.
3. 3Apply the separate lease test. Does it add the right to use an extra asset? Is the price increase commensurate with the standalone price? If both are yes, account for a new lease and leave the old one alone.
4. 4If not separate, set the revised lease term and the revised discount rate at the modification date. Discount the revised remaining payments to get the new liability.
5. 5Decide where the difference goes. For a decrease in scope, cut the ROU asset proportionately and take the gain or loss to profit or loss. For anything else, adjust the ROU asset.
6. 6If it is a reassessment, choose the rate. Use a revised rate for a term or purchase option change. Use the original rate for a change in an index or residual value guarantee.
7. 7Check the COVID-19 expedient if the scenario mentions pandemic rent relief. Test the conditions before you use it.
8. 8Finish with the follow-on effect. Depreciate the adjusted ROU asset over the revised term or useful life. Unwind interest on the new liability. Add the professional comment the requirement asks for.

Quickest way: Three-question triage

Common mistakes in Lease Modifications and Remeasurement

• Treating every extension of term as a separate lease.

  Students see 'extra years' and think 'extra lease'.

  Fix: A separate lease needs extra scope, meaning an additional underlying asset, plus a commensurate price. A pure term extension of the same asset is a modification that remeasures the liability.

• Using the original discount rate for a modification or a term reassessment.

  Students keep the rate from day one because it is on the schedule.

  Fix: Use a revised rate at the modification date or reassessment date. The original rate is only kept for changes in an index or residual value guarantee payments, with the floating-rate exception.

• Putting the whole adjustment for a scope decrease into profit or loss, or into the ROU asset.

  Students forget the proportionate split.

  Fix: Reduce the ROU asset by the proportion of scope removed. The gain or loss is the reduction in liability minus the reduction in ROU asset. Any remainder from the rate change goes against the ROU asset.

• Remeasuring on the date the idea was first discussed instead of the effective date.

  Scenario dates are scattered across the question.

  Fix: A modification is accounted for from the date both parties agree to it. A reassessment is made at the date of the triggering event or change.

• Applying the COVID-19 expedient to any rent concession.

  Students remember the headline and skip the conditions.

  Fix: Check all conditions. It must be a direct result of COVID-19, the total consideration must be substantially the same or less, and the reduction must only affect payments due on or before 30 June 2022. There must be no other substantive change.

• Forgetting depreciation and interest after the adjustment.

  Students stop once the journal balances at the modification date.

  Fix: State that the revised ROU asset is depreciated over the remaining term, or useful life if ownership transfers. State that interest runs on the new liability at the revised rate.

Worked examples