Corporate Financial Reporting · Leases (Ind AS 116)

Lease Modification Accounting and Lease Liability Remeasurement under Ind AS 116

Updated 11 October 2026 · Fact-checked

A lease modification is a change in the scope or consideration of a lease that was not in the original terms. A lessee treats it as a separate lease if scope increases and the price is commensurate. Otherwise it remeasures the lease liability at a revised discount rate and adjusts the right-of-use asset.

Understand Lease Modifications and Reassessment

A lease is accounted for at the commencement date. After that, things change. Rent may be revised, the term may be extended, or part of the space may be handed back. Ind AS 116 gives two different routes, and you must pick the right one first.

Reassessment covers changes that happen under the existing contract, such as a change in an index or rate, or a change in the amount payable under a residual value guarantee. Lease modification is a change in scope or consideration that was not part of the original terms, for example adding or terminating the right to use an underlying asset, or extending or shortening the contractual lease term.

For a modification, ask one question: is it a separate lease? A lessee accounts for it as a separate lease only if both conditions hold. The modification adds the right to use one or more underlying assets, and the consideration rises by an amount commensurate with the stand-alone price of that addition (adjusted for the contract's circumstances). If either condition fails, the modification is not a separate lease.

If it is not a separate lease, you work at the effective date of the modification. Allocate the consideration in the modified contract, determine the new lease term, and remeasure the lease liability by discounting the revised payments at a revised discount rate. The balancing entry depends on the type of change. A decrease in scope reduces the right-of-use asset, and any gain or loss on partial or full termination goes to profit or loss. All other modifications adjust the right-of-use asset.

For lessors, the same logic applies to finance leases: a modification is a separate lease if scope increases at a commensurate price. Lease classification is done at inception and is reassessed only if there is a lease modification. Changes in estimates or circumstances, such as a lessee default, do not trigger reclassification.

Key rules to remember

Separate lease test (lessee): Separate lease = scope increases (right to use added underlying asset) AND price increase = commensurate with stand-alone price; Both conditions are needed. Appropriate adjustments to the stand-alone price for the contract's circumstances are allowed.
Modification not a separate lease: steps: At effective date: allocate consideration → determine lease term → remeasure liability at revised discount rate; Revised rate is the rate implicit in the lease for the remaining term if readily determinable, otherwise the lessee's incremental borrowing rate at the effective date of the modification.
Decrease in scope: Reduce ROU asset for the partial or full termination; gain or loss to profit or loss; Any other change in the liability then adjusts the ROU asset.
Other modifications: Change in lease liability = corresponding adjustment to ROU asset; Applies to all modifications that are not separate leases and do not decrease scope.
Reassessment: index, rate or residual value guarantee: Remeasure liability by discounting revised lease payments; adjustment goes to ROU asset; Use an unchanged discount rate unless the change comes from floating interest rates, in which case use a revised rate. For an index or rate change, remeasure only when the cash flows actually change.
ROU asset reduced to zero: If ROU = 0 and the liability falls further, the balance goes to profit or loss; Applies to remeasurement adjustments in reassessments.
Lessor, finance lease modification: Separate lease if scope increases at commensurate price; else, if it would have been an operating lease at inception, treat as new lease with carrying amount = net investment; otherwise apply Ind AS 109; Lease classification is reassessed only on a modification.

How to solve Lease Modifications and Reassessment questions

Use this order for any question on modifications or remeasurement. The order matters because the accounting depends on the first answer.

1Identify whether the event is a change under the existing contract (index, rate, residual value guarantee, term reassessment) or a lease modification (change in scope or consideration not in the original terms).
2If it is a modification, apply the separate lease test: does it add the right to use an underlying asset, and is the price increase commensurate with the stand-alone price? If both are yes, account for a new lease alongside the old one, and leave the original lease unchanged.
3If it is not a separate lease, fix the effective date of the modification and allocate the consideration in the modified contract.
4Determine the revised lease term and revised payments. Choose the discount rate: for a modification, a revised rate (implicit rate if readily determinable, else incremental borrowing rate at the effective date). For an index or residual value change, keep the old rate unless it is a floating-rate change.
5Remeasure the lease liability by discounting the revised payments. Compute the change against the carrying amount just before the modification.
6Pick the balancing entry. Decrease in scope: reduce the ROU asset proportionately, take gain or loss to profit or loss, and put the rest of the liability change to ROU. Other cases: adjust the ROU asset fully. If ROU reaches zero, the remainder goes to profit or loss.
7Pass the journal entries, check that the new liability equals the present value of revised payments, and state the revised ROU asset carrying amount.

Quickest way: Two-gate shortcut for modification questions

When to use it: Use it in MCQs and in the first minute of a descriptive question, before doing any present value workings.

Gate 1: Is scope increased by adding an asset? If no, it cannot be a separate lease. Extension of term or reduction in space alone is never a separate lease.
Gate 2: Is the extra price commensurate with the stand-alone price? If no, it is not a separate lease.
If it passes both gates, no remeasurement of the old lease: book a new ROU asset and liability for the added item.
If it fails, remeasure the old liability with a revised rate. Scope decrease: part goes to profit or loss. Anything else: only ROU changes.
For an index or rate change, the discount rate stays the same. Only a floating-rate change, or a change in the lease term assessment, brings a revised rate.

Common mistakes in Lease Modifications and Reassessment

Treating a lease extension as a separate lease.
Students see higher total rent and assume the price increase is commensurate.
Fix: A separate lease needs added right to use an underlying asset. An extension of term alone only changes the term of the existing lease, so remeasure the liability.
Using the original discount rate for a modification that is not a separate lease.
The same rate is kept for reassessments for index changes, so students carry it over.
Fix: For a modification, use a revised rate at the effective date of the modification. Keep the unchanged rate for residual value guarantee and index/rate changes, except where the change in payments results from a change in floating interest rates, in which case use a revised rate.
Taking the whole change in liability to profit or loss on a scope decrease.
Students remember that gain or loss arises on partial termination.
Fix: Only the gain or loss on the part terminated goes to profit or loss. The remaining liability change is adjusted against the ROU asset.
Remeasuring on an index change before the new payment takes effect.
Students remeasure when the rent review is announced.
Fix: Remeasure only when the adjustment to the payments takes effect, that is, when the cash flows change.
Reclassifying a lessor's lease when the lessee defaults or estimates change.
Students confuse accounting for credit losses or estimate changes with classification.
Fix: Classification is made at inception and is reassessed only on a lease modification. Estimate or circumstance changes do not reclassify.
Dropping a negative ROU balance instead of recognising profit.
Students keep adjusting the ROU asset below zero.
Fix: If the ROU asset is reduced to zero and the liability falls further, take the remaining amount to profit or loss.

Worked examples

Example 1

Sunrise Textiles Ltd leases a warehouse. Just before a modification, the lease liability is ₹10,00,000 and the ROU asset is ₹9,00,000. The modification reduces the leased space by 40% and changes rent. At the effective date, the remeasured lease liability (revised payments at a revised discount rate) is ₹5,50,000. Assume the partial termination is measured proportionately (40% of the old liability and old ROU). Show the accounting.

Show the solution

The modification reduces scope, so it is not a separate lease. Remeasure using the revised rate; the question gives the new liability of ₹5,50,000.
Part terminated: ROU asset reduction = 40% × ₹9,00,000 = ₹3,60,000. Liability reduction = 40% × ₹10,00,000 = ₹4,00,000.
Gain on partial termination = ₹4,00,000 − ₹3,60,000 = ₹40,000, taken to profit or loss.
Liability after termination = ₹10,00,000 − ₹4,00,000 = ₹6,00,000. Remeasured to ₹5,50,000, so a further decrease of ₹50,000, adjusted against the ROU asset.
ROU asset after termination = ₹9,00,000 − ₹3,60,000 = ₹5,40,000. After adjustment = ₹5,40,000 − ₹50,000 = ₹4,90,000.
Check: total liability decrease ₹4,50,000 = gain ₹40,000 + ROU reduction ₹3,60,000 + ROU adjustment ₹50,000.

Answer: Dr Lease liability ₹4,50,000; Cr ROU asset ₹4,10,000; Cr Profit or loss (gain) ₹40,000. Closing liability ₹5,50,000; ROU asset ₹4,90,000.

Example 2

Kaveri Retail Ltd leases 3 floors of a building. In year 3, the lease is modified to add 1 more floor for the remaining term. Case A: additional rent equals the stand-alone price of a similar floor. Case B: additional rent is well below the stand-alone price, and the lessee's remeasured liability for the whole modified lease is ₹14,50,000 against a carrying amount of ₹12,00,000 before modification. Give the accounting for each case.

Show the solution

Test condition 1: the modification adds the right to use an underlying asset (one more floor). This is met in both cases.
Case A: condition 2 is met because the price increase is commensurate with the stand-alone price. It is a separate lease.
Case A accounting: recognise a new lease (ROU asset and lease liability) for the added floor under Ind AS 116. The original lease for 3 floors continues unchanged.
Case B: condition 2 fails as the price is not commensurate. It is not a separate lease.
Case B accounting: at the effective date allocate the consideration, determine the lease term, and discount the revised payments at a revised discount rate (implicit rate if readily determinable, else incremental borrowing rate at that date).
Increase in liability = ₹14,50,000 − ₹12,00,000 = ₹2,50,000. Scope has not decreased, so the adjustment goes to the ROU asset.

Answer: Case A: separate lease; no change to the original lease. Case B: Dr ROU asset ₹2,50,000; Cr Lease liability ₹2,50,000, with the liability remeasured at a revised discount rate.

Exam tips

Start every answer with the separate lease test and say both conditions in one line. Marks are given for the test, even if the numbers go wrong.
For numerical questions, state the discount rate you use and why. Revised rate for modifications; unchanged rate for index or residual value changes unless floating rates.
For scope decrease questions, show the split clearly: gain or loss to profit or loss, balance to ROU asset. Do a check that the entries tie to the change in liability.
In MCQs, watch for the words extension of term only, price not commensurate, and lessor default. Each points to not a separate lease or no reclassification.
If the question assumes a proportionate method for partial termination, say so in your answer and apply it consistently.

Practice questions from Leases (Ind AS 116)

Lease Modifications and Reassessment in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Lease Modifications and Reassessment: frequently asked questions

When is a lease modification a separate lease for a lessee?

Only when both conditions are met. The modification adds the right to use one or more underlying assets, and the consideration increases by an amount commensurate with the stand-alone price for that addition, with suitable adjustments for the contract. If either fails, it is not a separate lease.

Which discount rate is used when remeasuring the lease liability?

For a modification that is not a separate lease, use a revised rate at the effective date: the rate implicit in the lease for the remaining term if it can be readily determined, otherwise the incremental borrowing rate. For changes in an index or rate, or residual value guarantees, the unchanged rate is used unless the change arises from floating interest rates.

Where does the adjustment go when the lease liability is remeasured?

Generally to the right-of-use asset. For a modification that decreases scope, the ROU asset is reduced for the part terminated and the gain or loss goes to profit or loss. If the ROU asset reaches zero and the liability falls further, the remainder goes to profit or loss.

Is there any relief for rent concessions?

Yes. As a practical expedient, a lessee may elect not to assess whether a rent concession that meets the specified conditions is a lease modification. The lessee then accounts for the change in payments as if it were not a modification.