Accounting by lessees (IFRS 16)
7.1 Recognition – general
At the commencement date of a lease, a lessee is required to recognise both:
[IFRS 16:22]
• a right-of-use asset; and
• a lease liability.
7.2 Recognition exemptions
7.2.1 Recognition exemptions – general A lessee may elect not to apply the requirements in IFRS 16:22 to 49 (recognition requirements as described at 7.1, measurement requirements described at 7.4, and presentation requirements described at 7.1) to:
[IFRS 16:5]
• short-term leases (see 7.2.2); and
• leases for which the underlying asset is of low value (see 7.2.3 and subject to the exception in 7.2.3.5).
For short-term leases or leases of low-value items to which this exemption is applied, lease payments are recognised as an expense over the lease term (see 7.2.4).
Thinking it through Some entities may decide that they do not wish to take advantage of these exemptions, perhaps because recognising lease assets and liabilities and presenting the lease expense as interest and depreciation is considered preferable to an off-balance sheet treatment with an operating expense. Or, for some lessees, while they may see benefit to having such leases off-balance sheet, that benefit may not be sufficient to justify the additional cost or complexity of having two lease accounting systems.
7.2.2 Short-term leases
7.2.2.1 Short-term lease – definition A short-term lease is defined as “[a] lease that, at the commencement date, has a lease term of 12 months or less”. [IFRS 16:Appendix A]
A lease that contains a purchase option cannot be classified as a short-term lease. [IFRS 16:Appendix A]
For the purposes of the definition of a short-term lease, the lease term should be determined under the general requirements of IFRS 16 (see section 5). Consequently, lessees will need to assess the effect of extension and termination options.
Note that the prohibition on a lease containing a purchase option being classified as a short-term lease applies for any lease containing a purchase option, irrespective of the probability that the option will be exercised.
Note also that there is no restriction on qualification as a short-term lease based on the value of the underlying asset or the amount of the consideration paid. This exemption is available for high-value items that are leased for the short term.
7.2.2.2 Election to be made on a class-by-class basis The election to take the recognition exemption for short-term leases is required to be made by class of underlying asset to which the right of use relates. A class of underlying asset is a grouping of underlying assets of a similar nature and use in an entity’s operations. [IFRS 16:8]
For example, consider an entity that has leased several items of office equipment – some for less than 12 months and some for longer than 12 months, with none containing purchase options. Assuming that the items of office equipment are all considered to be of the same class, if the entity wishes to use the short-term lease exemption it must apply that exemption for all of the leases with terms of 12 months or less. The leases with terms longer than 12 months will be accounted for in accordance with the general recognition and measurement requirements for lessees.
7.2.2.3 Impact of lease modifications If a lessee accounts for short-term leases applying IFRS 16:6 (see 7.2.4), it should consider the lease to be a new lease for the purposes of IFRS 16 if:
[IFRS 16:7]
• there is a lease modification; or
• there is any change in the lease term (e.g. the lessee exercises an option not previously included in its determination of the lease term).
See 7.7 for the definition of lease modifications and the accounting treatment generally required. In the context of a short-term lease, any lease modification (and, specifically, any change in the lease term) will be considered a new lease which will need to be reassessed to determine if it qualifies for the short-term lease exemption.
See 1.4 for IFRS 16’s requirements regarding circumstances when two or more contracts that are interdependent should be combined and accounted for as a single contract. One specific example cited in this regard is when a lessee enters into a number of one-year leases at the same time and with the same counterparty, to follow sequentially such that the overall economic effect is a lease for the entire term. In that situation, if the conditions in IFRS 16:B2 are met, the leases would be combined and accounted for as a single lease (which would not qualify for the short-term lease exemption).
7.2.3 Leases of low-value assets
7.2.3.1 Low-value assets – definition and examples
IFRS 16 does not provide an explicit definition for what is meant by ‘low-value’ assets. However, the Basis of Conclusions states that “[a]t the time of reaching decisions about the exemption in 2015, the IASB had in mind leases of underlying assets with a value, when new, in the order of magnitude of US$5,000 or less”. [IFRS 16:BC100]
Examples of low-value underlying assets can include tablet and personal computers, small items of office furniture and telephones. [IFRS 16:B8]
7.2.3.2 Assessment independent of the size or nature of the lessee The assessment as to whether an underlying asset is of low value is performed on an absolute basis. Subject to the exception in IFRS 16:B7 regarding head leases (see 7.2.3.6), and the exclusion of assets that are highly dependent on, or interrelated with, other assets (see 7.2.3.5), leases of low-value assets qualify for the accounting treatment in IFRS 16:6 (see 7.2.4) regardless of whether those leases are material to the lessee. The assessment is not affected by the size, nature or circumstances of the lessee. Accordingly, different lessees are expected to reach the same conclusions about whether a particular underlying asset is of low value.
Thinking it through In practice, determining whether items are of 'low value' is going to be challenging given that the pointers in the guidance are so limited. While US$5,000 may be considered 'low' in some jurisdictions, it may not be in others, and it is possible that some lessees will put more focus on the nature of the underlying assets (the Standard cites as examples tablet and personal computers, small items of office furniture and telephones). It is likely that this will continue to be a significant area of judgement which may become clearer as practice develops.
7.2.3.3 Assessment to be based on the value of the asset when new The value of an underlying asset should be assessed based on the value of the asset when it is new, regardless of the age of the asset being leased. [IFRS 16:B3]
A lease of an underlying asset does not qualify as a lease of a low-value asset if the nature of the asset is such that, when new, the asset is typically not of low value. For example, leases of cars would not qualify as leases of low-value assets because a new car would typically not be of low value. [IFRS 16:B6]
7.2.3.4 Election available on lease-by-lease basis The exemption for leases of low-value assets is available on a lease-by-lease basis. [IFRS 16:8]
In particular, an entity is not required to consider the aggregate of the leases identified as relating to low-value assets to determine if the overall effect is material (see also 7.2.3.2).
Subject to IFRS 16’s general requirements regarding the combination of interdependent contracts (see 1.4), and the specific requirements in IFRS 16:B5 regarding assets that are highly interdependent or highly interrelated (see 7.2.3.5), each lease is assessed separately.
For example, a hospital enters into a rental contract for a large number of hospital beds. Each bed within the contract constitutes an identified underlying asset and the other conditions for identification of a lease are met. The value of an individual hospital bed would be considered to be ‘low’, even though the contract for all of the beds is not. The conditions of IFRS 16:B5 are met (the hospital can benefit from the use of an individual bed together with other resources that are already available, and each individual bed does not need other assets to make it functional for patients). Consequently each bed qualifies as a low-value asset and the entity can elect to apply the low- value asset exemption to all of the beds under the contract.
7.2.3.5 Assets that are highly dependent on, or highly interrelated with, other assets do not qualify as low-value assets A lease will qualify for this exemption only if:
[IFRS 16:B5]
• the lessee can benefit from use of the underlying asset on its own or together with other resources that are readily available to the lessee; and
• the underlying asset is not highly dependent on, or highly interrelated with, other assets.
7.2.3.3 Assessment to be based on the value of the asset when new The value of an underlying asset should be assessed based on the value of the asset when it is new, regardless of the age of the asset being leased. [IFRS 16:B3]
A lease of an underlying asset does not qualify as a lease of a low-value asset if the nature of the asset is such that, when new, the asset is typically not of low value. For example, leases of cars would not qualify as leases of low-value assets because a new car would typically not be of low value. [IFRS 16:B6]
7.2.3.4 Election available on lease-by-lease basis The exemption for leases of low-value assets is available on a lease-by-lease basis. [IFRS 16:8]
In particular, an entity is not required to consider the aggregate of the leases identified as relating to low-value assets to determine if the overall effect is material (see also 7.2.3.2).
Subject to IFRS 16’s general requirements regarding the combination of interdependent contracts (see 1.4), and the specific requirements in IFRS 16:B5 regarding assets that are highly interdependent or highly interrelated (see 7.2.3.5), each lease is assessed separately.
For example, a hospital enters into a rental contract for a large number of hospital beds. Each bed within the contract constitutes an identified underlying asset and the other conditions for identification of a lease are met. The value of an individual hospital bed would be considered to be ‘low’, even though the contract for all of the beds is not. The conditions of IFRS 16:B5 are met (the hospital can benefit from the use of an individual bed together with other resources that are already available, and each individual bed does not need other assets to make it functional for patients). Consequently each bed qualifies as a low-value asset and the entity can elect to apply the low- value asset exemption to all of the beds under the contract.
7.2.3.5 Assets that are highly dependent on, or highly interrelated with, other assets do not qualify as low-value assets A lease will qualify for this exemption only if:
[IFRS 16:B5]
• the lessee can benefit from use of the underlying asset on its own or together with other resources that are readily available to the lessee; and
• the underlying asset is not highly dependent on, or highly interrelated with, other assets.
Therefore, if either (1) the lessee cannot benefit from the underlying asset on its own or together with other readily available resources, or (2) the underlying asset is highly dependent on, or highly interrelated with, other underlying assets, the recognition exemption for low-value assets cannot be applied to that individual asset (unless the overall asset, combining the highly dependent or highly interrelated assets, is itself low value). In this context, the IASB had in mind large assets made up of a number of individual leases of low- value assets (such as IT equipment made up of individually low-value component parts).
See example 1.3 which sets out a scenario in which some items of IT equipment (laptop computers, desktop computers, hand held computer devices, desktop printers and mobile phones) qualify for the low-value asset exemption but others (individual modules that increase the storage capacity of mainframe servers) do not. Although each module within the servers, if considered individually, might be an asset of low value, the leases of modules within the servers do not qualify as leases of low-value assets. This is because each module is highly interrelated with other parts of the servers.
7.2.3.6 Head leases do not qualify as low-value assets If a lessee subleases an asset, or expects to sublease an asset, the head lease does not qualify as a lease of a low-value asset. [IFRS 16:B7]
7.2.4 Recognition of lease payments for short-term leases and leases of low-value assets If a lessee elects to apply the exemption in IFRS 16:5 to either short-term leases or leases of low-value assets, it should recognise the lease payments associated with those leases as an expense on either a straight-line basis over the lease term, or on another systematic basis if that basis is more representative of the pattern of the lessee’s benefit. [IFRS 16:6]
For example, if the lease payments for an asset are based on the actual usage of that asset, or are revised periodically to reflect the efficiency of the asset or current market rates, the amounts actually payable may be an appropriate measure.
The lease payments to be spread on a straight-line (or other systematic) basis are after deduction of any lease incentives (see 6.4). The lease term includes any rent-free periods (see 5.4). The following examples illustrate the recognition of lease payments under IFRS 16:6 when such features are present.
Example 7.2.4A
Recognition of lease payments (including lease incentives) for low-value assets Entity A leases office equipment for 5 years. The total value of the equipment when new is CU5,000 (determined by Entity A to be ‘low value’). Entity A elects to apply the low-value asset exemption.
Lease payments are payable as follows.
Year 1 CUnil (rent-free period)
Years 2 and 3: CU1,750 per year
Years 4 and 5: CU1,500 per year
In addition, the lessor provides a lease incentive with a value of CU500. The lessee’s benefit under the lease arises on a straight-line basis over the full lease term.
Applying IFRS 16:6 to the lease payments:
Total payments: (CU1,750 x 2) + (CU1,500 x 2) – CU500 = CU6,000
Length of lease: 5 years
Lease expense recognised each year: CU1,200 (CU6,000/5)
Example 7.2.4B Period over which lease incentives should be recognised Entity B leases office equipment for 5 years. The total value of the equipment when new is CU5,000 (determined by Entity B to be ‘low value’). Entity B elects to apply the low-value asset exemption.
The lease includes a clause requiring lease payments to be repriced to market rates part-way through the lease term. The lessor grants an incentive to Entity B to enter into the lease arrangement.
Over what period should the lease incentive be recognised (i.e. over the whole of the lease term or over the period up to the repricing of lease payments to market rates)?
The lease incentive should be recognised over the lease term. It should be recognised on a straight-line basis, unless another systematic basis is more representative of the time pattern of Entity B’s benefit from use of the leased asset.
The IFRIC (now the IFRS Interpretations Committee) was asked to consider this issue in 2005 (in the context of SIC-15 Operating Leases – Incentives, but equally applicable for entities applying the low-value asset exemption under IFRS 16). Specifically, the IFRIC was asked to consider whether the lease incentive should be recognised over the shorter period ending when the lease payments are adjusted to market rates on the basis that the lease expense of a lessee after a lease is repriced to market ought to be comparable with the lease expense of an entity entering into a new lease at that same time at market rates. The IFRIC did not accept this argument and confirmed that the general requirements for spreading lease incentives over the entire lease term should apply.
7.3 Lessee involvement with the underlying asset before the commencement date
7.3.1 Costs of the lessee relating to the construction or design of the underlying asset Parties may negotiate a lease before the underlying asset is available for use by the lessee. For some leases, the underlying asset may need to be constructed or redesigned for use by the lessee. Depending on the terms and conditions of the contract, a lessee may be required to make payments relating to the construction or design of the asset. If a lessee incurs costs relating to the construction or design of an underlying asset, the lessee should account for those costs applying other applicable Standards (e.g. IAS 16 Property, Plant and Equipment). [IFRS 16:B43 & B44]
Such costs (e.g. amounts payable by an entity to construct a bespoke property that it will ultimately lease from another entity – sometimes referred to as ‘build-to-suit’ leases) do not qualify as initial direct costs (as discussed at 7.4.1.2); they are not included within the carrying amount of the right-of-use asset under IFRS 16, but rather are accounted for as a separate asset (assuming the recognition criteria of the relevant Standard are met).
7.3.2 Payments for the right to use the underlying asset made before the commencement date Costs relating to the construction or design of an underlying asset (as described in 7.3.1) do not include payments made by the lessee for the right to use the underlying asset. Payments for the right to use an underlying asset are payments for a lease, regardless of the timing of those payments. [IFRS 16:B44] They are included within the initial measurement of the right-of-use asset (see 7.4.1)
7.3.3 Legal title to the underlying asset A lessee may obtain legal title to an underlying asset before that legal title is transferred to the lessor and the asset is leased to the lessee. Obtaining legal title does not in itself determine how to account for the transaction. [IFRS 16:B45]
If the lessee controls (or obtains control of) the underlying asset before that asset is transferred to the lessor, the transaction is a sale and leaseback transaction accounted for by applying IFRS 16:98 to 103 (see section 10). [IFRS 16:B46]
However, if the lessee does not obtain control of the underlying asset before the asset is transferred to the lessor, the transaction is not a sale and leaseback transaction. For example, this may be the case if a manufacturer, a lessor and a lessee negotiate a transaction for the purchase of an asset from the manufacturer by the lessor, which is in turn leased to the lessee. The lessee may obtain legal title to the underlying asset before legal title transfers to the lessor. In this case, if the lessee obtains legal title to the underlying asset but does not obtain control of the asset before it is transferred to the lessor, the transaction is not accounted for as a sale and leaseback transaction, but as a lease. [IFRS 16:B47]
Lease liability Right-of-use asset
7.4.1 Initial measurement of the right-of-use asset
7.4.1.1 Right-of-use asset to be measured initially at cost At the commencement date, the right-of-use asset should be measured at cost. [IFRS 16:23]
For this purpose, cost comprises:
[IFRS 16:24]
a) the amount of the initial measurement of the lease liability, as described in IFRS 16:26 (see 7.4.2);
b) any lease payments made at or before the commencement date (see 7.3.2), less any lease incentives received (see 6.4 for a definition of
lease incentives);
c) any initial direct costs incurred by the lessee (see 7.4.1.2); and
d) an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it
is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to produce inventories. The lessee incurs the obligation for those costs either at the commencement date or as a consequence of having used the asset during a particular period (see 7.4.1.3).
See example 7.6 for an illustration of the initial and subsequent measurement of a lessee’s right-of-use asset and lease liability.
49
7.4.1.2 Initial direct costs Initial direct costs are the “[i]ncremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained, except for such costs incurred by a manufacturer or dealer lessor in connection with a finance lease”. [IFRS 16:Appendix A]
Initial direct costs are, typically, costs incurred in negotiating and securing lease arrangements. They exclude costs incurred by a lessee relating to the construction or design of an underlying asset (see 7.3.1). See 9.1.1.3 for further discussion on the nature of initial direct costs.
7.4.1.3 Restoration costs Under IFRS 16:24(d), the initial cost of a right-of-use asset includes an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to produce inventories.
The lessee incurs the obligation for those costs either at the commencement date or as a consequence of having used the underlying asset during a particular period. [IFRS 16:24(d)]
The costs described in IFRS 16:24(d) should be recognised as part of the cost of the right-of-use asset when the lessee incurs an obligation for those costs. The lessee should apply IAS 2 Inventories to costs that are incurred during a particular period as a consequence of having used the right-of-use asset to produce inventories during that period. The obligations for such costs accounted for applying IFRS 16 or IAS 2 are recognised and measured applying IAS 37 Provisions, Contingent Liabilities and Contingent Assets. [IFRS 16:25]
At initial recognition, the estimated liability for such restoration costs is recognised as a provision under IAS 37 Provisions, Contingent Liabilities and Contingent Assets if an obligating event has already occurred. It is not included as part of the lease liability.
As a consequential amendment arising from IFRS 16, the scope of IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities has been amended to include restoration costs of this nature that are recognised as part of the cost of a right-of-use asset under IFRS 16:24(d). Therefore, any change in the entity’s estimate of such costs after initial recognition should be accounted for in accordance with that Interpretation which, for right-of-use assets measured subsequent to initial recognition using a cost model, will result in such changes being added to, or deducted from, the cost of the right-of-use asset.
Sometimes lease contracts stipulate that the underlying asset must be returned to the lessor in the same condition as when originally leased. The appropriate accounting in such circumstances depends on the particular lease clause. For example, the underlying asset may suffer general wear and tear that is merely a result of being used. In such circumstances, it may be necessary gradually to build up a provision to repair or maintain the asset over the lease term, so that it can be returned to the lessor in its original condition. Generally, in these circumstances, it would be inappropriate to recognise a provision for all of the estimated maintenance costs at the outset of the lease. Conversely, other contracts may require specific work to be performed; for example, the contract may stipulate that the asset must be painted at the end of the lease before being returned to the lessor. In such circumstances, it may be appropriate to recognise a provision at the outset of the lease because, by signing the lease contract, the entity has committed itself to painting the asset, irrespective of any wear and tear suffered.
7.4.2 Initial measurement of the lease liability
7.4.2.1 Lease liability to be measured initially at the present value of unpaid lease payments At the commencement date, the lease liability should be measured at the present value of the lease payments that are not paid at that date. [IFRS 16:26]
See section 6 for a discussion of the components of ‘lease payments’ for the purposes of this measurement.
Thinking it through In some industries, analysts have historically applied a specific multiple to operating lease expenses under IAS 17 to arrive at a proxy for the liability now being recognised under IFRS 16. For example, in the aviation industry, it has been common practice to use a multiple of seven, regardless of the outstanding term of lease arrangements. Accordingly, the liability recognised under IFRS 16 may differ significantly to the proxies previously arrived at by analysts. In such circumstances, entities will want to speak to their investors and analysts to manage expectations and avoid ‘surprises’.
The liability may also be treated as ‘debt’ for some purposes, although this will depend on the particular circumstances.
7.4.2.2 Discount rate The lease payments should be discounted using:
[IFRS 16:26]
• the interest rate implicit in the lease; or
• if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate.
The interest rate implicit in the lease is defined as “[t]he rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor”. [IFRS 16:Appendix A] The unguaranteed residual value is defined as “[t]hat portion of the residual value of the underlying asset, the realisation of which by a lessor is not assured or is guaranteed solely by a party related to the lessor". [IFRS 16:Appendix A]
The lessee’s incremental borrowing rate is defined as “[t]he rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment". [IFRS 16:Appendix A]
When the lease is denominated in a foreign currency, the lessee’s incremental borrowing rate should be the rate at which the lessee could obtain funding for the asset in the foreign currency.
The IASB’s objective in specifying the discount rate to apply to a lease is to specify a rate that reflects how the contract is priced. With this in mind, the IASB decided that, if readily determinable by the lessee, a lessee should use the interest rate implicit in the lease. [IFRS 16:BC160]
The interest rate implicit in the lease is likely to be similar to the lessee’s incremental borrowing rate in many cases. This is because both rates, as they have been defined in IFRS 16, take into account the credit standing of the lessee, the length of the lease, the nature and quality of the collateral provided and the economic environment in which the transaction occurs. However, the interest rate implicit in the lease is generally also affected by a lessor’s estimate of the residual value of the underlying asset at the end of the lease, and may be affected by taxes and other factors known only to the lessor, such as any initial direct costs of the lessor. Consequently, the IASB noted that it is likely to be difficult for lessees to determine the interest rate implicit in the lease for many leases, particularly those for which the underlying asset has a significant residual value at the end of the lease. [IFRS 16:BC161]
The IASB noted that, depending on the nature of the underlying asset and the terms and conditions of the lease, a lessee may be able to refer to a rate that is readily observable as a starting point when determining its incremental borrowing rate for a lease (e.g. the rate that a lessee has paid, or would pay, to borrow money to purchase the type of asset being leased, or the property yield when determining the discount rate to apply to property leases). Nonetheless, because the lessee’s incremental borrowing rate is defined to take into account the terms and conditions of the lease, a lessee should adjust such observable rates as needed to determine its incremental borrowing rate. [IFRS 16:BC162]
Thinking it through In attempting to arrive at an appropriate discount rate, some lessees may decide to approach lessors in order to obtain greater insight into the pricing of contracts and returns being made by lessors. In some industries and for some lessors, this may not be sensitive information and the lessors may readily provide it. In other cases, lessors may be reluctant to divulge such information for commercial reasons and lessees will need to consider whether the implicit rate is readily determinable by other means, before resorting to the incremental borrowing rate.
7.5 Subsequent measurement
7.5.1 Subsequent measurement of the right-of-use asset
7.5.1.1 Subsequent measurement of the right-of-use asset – general After the commencement date, the right-of-use asset should be measured using a cost model (see 7.5.1.2), unless it applies either of the measurement models described in IFRS 16:34 and 35 (see 7.5.1.5 and 7.5.1.6, respectively). [IFRS 16:29]
7.5.1.2 Cost model for right-of-use assets Under the cost model, the right-of-use asset is measured at cost:
[IFRS 16:30]
• less any accumulated depreciation and any accumulated impairment losses (see 7.5.1.3 and 7.5.1.4, respectively); and
• adjusted for any remeasurement of the lease liability specified in IFRS 16:36(c) (see 7.5.2.1).
7.5.1.3 Depreciation for right-of-use assets Right-of-use assets measured under the cost model should be depreciated in accordance with the depreciation requirements in IAS 16, subject to the following:
[IFRS 16:31 & 32]
• if the lease transfers ownership of the underlying asset to the lessee by the end of the lease term, or if the cost of the right-of-use asset reflects that the lessee will exercise a purchase option, the right-of-use asset should be depreciated from the commencement date to the end of the useful life of the underlying asset;
• otherwise, the right-of-use asset should be depreciated from the commencement date to the earlier of the end of the useful life of the right-of-use asset and the end of the lease term.
The useful life of an asset is defined as “[t]he period over which an asset is expected to be available for use by an entity; or the number of production or similar units expected to be obtained from an asset by an entity”. [IFRS 16:Appendix A]
Therefore, if the ownership of the underlying asset transfers to the lessee at the end of the lease term, or it is reasonably certain that the lessee will exercise a purchase option, depreciation is based on the useful life of the underlying asset. Otherwise, depreciation is determined by reference to the useful life of the right-of-use asset (provided that is not longer than the lease term).
7.5.1.4 Impairment for right-of-use assets A lessee should apply IAS 36 Impairment of Assets to determine whether the right-of-use asset is impaired and to account for any impairment loss identified. [IFRS 16:33]
7.5.1.5 Right-of-use assets that meet the definition of investment property If a lessee applies the fair value model in IAS 40 Investment Property to its investment property, it is also required to apply that fair value model to right-of-use assets that meet the definition of investment property in IAS 40. [IFRS 16:34]
IFRS 16 has amended the scope of IAS 40 by defining investment property to include both owned investment property and investment property held by a lessee as a right-of-use asset. A lessee is required to account for right-of-use assets that meet the definition of investment property in a manner consistent with its policy for owned investment property – i.e. using either the cost model and disclosing fair value, or using the fair value model. [IFRS 16:BC178]
7.5.1.6 Right-of-use assets that relate to a class of revalued property, plant and equipment If right-of-use assets relate to a class of property, plant and equipment to which the lessee applies the revaluation model in IAS 16, a lessee may elect to apply that revaluation model to all of the right-of-use assets that relate to that class of property, plant and equipment. [IFRS 16:35]
Therefore, for property, plant and equipment:
• if the class of owned assets to which right-of-assets relate is measured using the cost model, the right-of-use assets should also be accounted for using the cost model; but
• if the class of assets to which right-of-use assets relate is measured using IAS 16’s revaluation model, a lessee can chose whether to measure right-of-use assets at fair value. This choice is made on a class-by-class basis. This is in contrast to right-of-use assets that meet the definition of investment property for which the accounting model to be followed is determined by the lessee’s accounting policy for owned investment property (see 7.5.1.5).
7.5.2 Subsequent measurement of the right-of-use liability
7.5.2.1 Subsequent measurement of the lease liability – general After the commencement date, the lease liability should be measured by:
[IFRS 16:36]
a) increasing the carrying amount to reflect interest on the lease liability;
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 in IFRS 16:39 to 46 (see 7.5.2.4), or to
reflect revised in-substance fixed lease payments (see 6.3).
Lease liabilities are measured on an ongoing basis similarly to other financial liabilities, using an effective interest method, so that the carrying amount of the lease liability is measured on an amortised cost basis and the interest expense is allocated over the lease term. IFRS 16 does not require or permit a lessee to measure lease liabilities at fair value after initial measurement. [IFRS 16:BC182 & BC183]
Thinking it through Accounting systems will need to be able to cater for scenarios where remeasurement of the liability is required, potentially with an updated discount rate. Basic spreadsheet solutions may struggle to cope with such demands as well as identifying when such remeasurements are required.
7.5.2.2 Recognising interest on the lease liability Interest on the lease liability in each period during the lease term should be the amount that produces a constant periodic rate of interest on the remaining balance of the lease liability. For this purposes, the periodic rate of interest is the discount rate used in the initial measurement of the lease liability (see 7.4.2.2) or, if applicable, the revised discount rate described in IFRS 16:41 or 43 (see 7.5.2.5 to 7.5.2.7) or IFRS 16:45(c) (see 7.7.3). [IFRS 16:37]
7.5.2.3 Amounts to be recognised in profit or loss After the commencement date, a lessee should recognise in profit or loss (unless the costs are included in the carrying amount of another asset under other applicable IFRSs), both:
[IFRS 16:38]
• interest on the lease liability; and
• 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 (see also 6.5.3).
Thinking it through Because the interest expense on the lease liability will be front-loaded, this leads to an overall front-loading of the expense when combined with straight-line depreciation of the right-of-use asset. This means that, for an individual lease, the expense will typically be higher in the earlier years (compared to the previous IAS 17 expense) and lower in the later years. However, when an entity has a portfolio of leases of varying maturities which are renewed on a rolling basis, the overall effect may still resemble an approximately straight-line expense, similar to that reported under IAS 17.
Recognising an interest and depreciation expense under IFRS 16, rather than an operating expense for rentals paid under IAS 17, means that metrics such as EBITDA will increase compared to amounts reported when IAS 17 is applied. This may have a knock-on effect on an entity’s KPIs, bonus targets, contingent consideration arrangements, lending covenants and more.
7.5.2.4 Remeasurement of the lease liability – general After the commencement date, if changes to the lease payments occur, the lease liability should be remeasured in accordance with IFRS 16:40 to 43 (see 7.5.2.5 to 7.5.2.7). The amount of the remeasurement of the lease liability should generally be recognised as an adjustment to the right-of-use asset (see 7.5.1.2). 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, the remaining remeasurement should be recognised in profit or loss. [IFRS 16:39]
7.5.2.5 Remeasurements arising from a change in the lease term or reassessment of purchase option The lease liability should be remeasured by discounting the revised lease payments using a revised discount rate, if either:
[IFRS 16:40]
• there is a change in the lease term (see 5.7 and 5.8), in which case the revised lease payments should be determined on the basis of the revised lease term; or
• there is a change in the assessment of an option to purchase the underlying asset, assessed considering the events and circumstances described in IFRS 16:20 and 21 (see 5.7 and 5.8) in the context of a purchase option, in which case the revised lease payments should be determined to reflect the change in amounts payable under the purchase option.
In most cases, an entity should not reassess the discount rate during the lease term. However, IFRS 16 requires a lessee to remeasure the lease liability using revised payments and a revised discount rate when there is a change in the lease term or a change in the assessment of whether the lessee is reasonably certain to exercise an option to purchase the underlying asset. In the IASB’s view, in those circumstances, the economics of the lease have changed and it is appropriate to reassess the discount rate to be consistent with the change in the lease payments included in the measurement of the lease liability (and right-of-use asset). [IFRS 16:B193 & BC194]
In applying IFRS 16:40, the revised discount rate used should be:
[IFRS 16:41]
• the interest rate implicit in the lease for the remainder of the lease term; or
• if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate at the date of reassessment.
7.5.2.6 Remeasurements arising from a change in the amounts expected to be payable under a residual value guarantee The lease liability should be remeasured by discounting the revised lease payments (i.e. reflecting the change in the residual value guarantee) using an unchanged discount rate, unless the change in the residual value guarantee results from a change in floating interest rates, in which case the lessee should use a revised discount rate that reflects changes in the interest rate. [IFRS 16:42(a) & 43]
7.5.2.7 Remeasurements arising from a change in future lease payments resulting from a change in an index or a rate These requirements apply when 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). In such circumstances, the lease liability should be remeasured 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 – see example 7.5.2.7). [IFRS 16:42(b)]
The IASB decided that a lessee should reassess variable lease payments that are determined by reference to an index or a rate only when there is a change in the cash flows resulting from a change in the reference index or rate. This approach is considered to be less complex and costly to apply than requiring a lessee to reassess variable lease payments at each reporting date. [IFRS 16:BC190]
The revised lease payments for the remainder of the lease term should be determined based on the revised contractual payments. They should be discounted using an unchanged discount rate, unless the change in the lease payments results from a change in floating interest rates, in which case the lessee should use a revised discount rate that reflects changes in the interest rate. [IFRS 16:42(b) & 43]
IFRS 16 generally does not permit an entity to reassess the discount rate during the lease term. An exception is made when there is a change in the lease term or a change in the assessment regarding a purchase option (see 7.5.2.5). The IASB also decided that, in a floating interest rate lease, a lessee should use a revised discount rate to remeasure the lease liability when there is a change in lease payments resulting from changes in the floating interest rate. This approach is consistent with the requirements in IFRS 9 Financial Instruments for the measurement of floating-rate financial liabilities subsequently measured at amortised cost. [IFRS 16:BC195]
Example 7.5.2.7
Remeasurements arising from a change in future lease payments resulting from a change in an index On 1 January 20X1, Entity A leases a property for a lease term of 8 years. The lease payments for the first three years have been agreed at CU100 per year. The lease payments will be reset on 1 January 20X4 (and, subsequently, on 1 January 20X7) on the basis of the increase in the Retail Price Index (RPI) for the preceding three years. All lease payments are made at the end of the relevant year.
At 1 January 20X1 (the commencement date), the RPI is 100 and Entity A measures its lease liability at CU646 (8 payments of CU100 payable in arrears, discounted at the interest rate implicit in the lease of 5 per cent).
On 1 January 20X2, 20X3 and 20X4, respectively, the RPI is 103, 107 and 108. On 1 January 20X7, the RPI is 113.
In its financial statements for the years ended 31 December 20X1, 31 December 20X2 and 31 December 20X3, Entity A makes no adjustment for increases in RPI because there is no change in cash flows in those years. In its financial statements for year ended 31 December 20X4 (and subsequently 20X7), Entity A recalculates its liability based on the increased RPI. These adjustments are added to the carrying amount of the lease liability and the related right-of-use asset, subject to the requirements of IFRS 16:39 (see 7.5.2.4).
a) Difference between five remaining payments of CU100 discounted at 5 per cent and five remaining payments of CU108 discounted
at 5 per cent.
b) Difference between two remaining payments of CU108 discounted at 5 per cent and two remaining payments of CU113 discounted
at 5 per cent.
7.5.2.8 Foreign currency exchange
IFRS 16 does not provide specific requirements as to how a lessee should account for the effects of foreign currency exchange differences relating to lease liabilities that are denominated in a foreign currency. In line with other financial liabilities, a lessee’s lease liability is a monetary item and consequently, if denominated in a foreign currency, is required to be remeasured using closing rates at the end of each reporting period applying IAS 21 The Effects of Changes in Foreign Exchange Rates. Such foreign exchange differences are recognised in profit in loss and not as an adjustment to the carrying amount of the right-of-use asset. [IFRS 16:BC196 – BC198]
Thinking it through In industries such as the aviation industry, it is common for leases to be denominated in US dollars (USD). For entities with functional currencies other than USD, the effects of retranslating the liability and recognising a gain or loss in profit or loss may be significant. Entities may wish to consider their treasury strategy and whether they can apply hedge accounting to address this volatility.
7.6 Illustrative example – lessee measurement The following example, reproduced from the illustrative examples accompanying IFRS 16, illustrates how a lessee measures right-of-use assets and lease liabilities. It also illustrates how a lessee accounts for a change in the lease term.
Example 7.6 Measurement by a lessee and accounting for a change in the lease term [IFRS 16:Illustrative example 13]
Part 1 – Initial measurement of the right-of-use asset and the lease liability
Lessee enters into a 10-year lease of a floor of a building, with an option to extend for five years. Lease payments are CU50,000 per year during the initial term and CU55,000 per year during the optional period, all payable at the beginning of each year. To obtain the lease, Lessee incurs initial direct costs of CU20,000, of which CU15,000 relates to a payment to a former tenant occupying that floor of the building and CU5,000 relates to a commission paid to the real estate agent that arranged the lease. As an incentive to Lessee for entering into the lease, Lessor agrees to reimburse to Lessee the real estate commission of CU5,000 and Lessee’s leasehold improvements of CU7,000.
At the commencement date, Lessee concludes that it is not reasonably certain to exercise the option to extend the lease and, therefore, determines that the lease term is 10 years.
The interest rate implicit in the lease is not readily determinable. Lessee’s incremental borrowing rate is 5 per cent per annum, which reflects the fixed rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a 10-year term, and with similar collateral.
At the commencement date, Lessee makes the lease payment for the first year, incurs initial direct costs, receives lease incentives from Lessor and measures the lease liability at the present value of the remaining nine payments of CU50,000, discounted at the interest rate of 5 per cent per annum, which is CU355,391.
Lessee initially recognises assets and liabilities in relation to the lease as follows.
Right-of-use asset CU405,391
Lease liability CU355,391
Cash (lease payment for the first year) CU50,000
Right-of-use asset CU20,000
Cash (initial direct costs) CU20,000
Cash (lease incentive) CU5,000
Right-of-use asset CU5,000
Lessee accounts for the reimbursement of leasehold improvements from Lessor applying other relevant Standards and not as a lease incentive applying IFRS 16. This is because costs incurred on leasehold improvements by Lessee are not included within the cost of the right-of-use asset.
Part 2 – Subsequent measurement and accounting for a change in the lease term
In the sixth year of the lease, Lessee acquires Entity A. Entity A has been leasing a floor in another building. The lease entered into by Entity A contains a termination option that is exercisable by Entity A. Following the acquisition of Entity A, Lessee needs two floors in a building suitable for the increased workforce. To minimise costs, Lessee (a) enters into a separate eight-year lease of another floor in the building leased that will be available for use at the end of Year 7 and (b) terminates early the lease entered into by Entity A with effect from the beginning of Year 8.
Moving Entity A’s staff to the same building occupied by Lessee creates an economic incentive for Lessee to extend its original lease at the end of the non-cancellable period of 10 years. The acquisition of Entity A and the relocation of Entity A’s staff is a significant event that is within the control of Lessee and affects whether Lessee is reasonably certain to exercise the extension option not previously included in its determination of the lease term. This is because the original floor has greater utility (and thus provides greater benefits) to Lessee than alternative assets that could be leased for a similar amount to the lease payments for the optional period – Lessee would incur additional costs if it were to lease a similar floor in a different building because the workforce would be located in different buildings. Consequently, at the end of Year 6, Lessee concludes that it is now reasonably certain to exercise the option to extend its original lease as a result of its acquisition and planned relocation of Entity A.
Lessee’s incremental borrowing rate at the end of Year 6 is 6 per cent per annum, which reflects the fixed rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a nine-year term, and with similar collateral. Lessee expects to consume the right-of-use asset’s future economic benefits evenly over the lease term and, thus, depreciates the right-of-use asset on a straight-line basis.
At the end of the sixth year, before accounting for the change in the lease term, the lease liability is CU186,162 (the present value of four remaining payments of CU50,000, discounted at the original interest rate of 5 per cent per annum). Interest expense of CU8,865 is recognised in Year 6. Lessee’s right-of-use asset is CU168,157.
Lessee remeasures the lease liability at the present value of four payments of CU50,000 followed by five payments of CU55,000, all discounted at the revised discount rate of 6 per cent per annum, which is CU378,174. Lessee increases the lease liability by CU192,012, which represents the difference between the remeasured liability of CU378,174 and its previous carrying amount of CU186,162. The corresponding adjustment is made to the right-of-use asset to reflect the cost of the additional right of use, recognised as follows.
Right-of-use asset CU192,012
Lease liability CU192,012
Following the remeasurement, the carrying amount of Lessee’s right-of-use asset is CU360,169 (ie CU168,157 + CU192,012). From the beginning of Year 7 Lessee calculates the interest expense on the lease liability at the revised discount rate of 6 per cent per annum.
7.7 Lease modifications 7.7.1 Lease modification – definition A ‘lease modification’ is defined as “[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]
The ‘effective date of the modification’ is “[t]he date when both parties agree to a lease modification”. [IFRS 16:Appendix A] 60Lease payment
5% interest expense
Ending balance
Beginning balance
Depreciation charge
7.7.2 Conditions for treating a lease modification as a separate lease A lease modification should be accounted for as a separate lease if both of the following apply:
[IFRS 16:44]
• 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 by an amount commensurate with the stand-alone price for the increase in scope and any appropriate adjustments to that stand-alone price to reflect the circumstances of the particular contract.
When the conditions in IFRS 16:44 are met, the modification is considered to result in the creation of a new lease that is separate from the original lease. [IFRS 16:BC202] The agreement for the right to use one or more additional assets is accounted for as a separate lease (or leases) to which the requirements of IFRS 16 are applied independently of the original lease.
The following example, reproduced from the illustrative examples accompanying IFRS 16, illustrates a modification that should be accounted for as a separate lease.
Example 7.7.2 Measurement by a lessee and accounting for a change in the lease term [IFRS 16:Illustrative example 15]
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.
7.7.3 Lease modifications that are not accounted for as 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 should:
[IFRS 16:45]
a) allocate the consideration in the modified contract applying the requirements of IFRS 16: 13 to 16 (see 4.2);
b) determine the lease term of the modified lease applying the requirements of IFRS 16:18 and 19 (see section 5); and
c) remeasure the lease liability by discounting the revised lease payments using a revised discount rate. The revised discount rate
is determined as:
i) the interest rate implicit in the lease for the remainder of the lease term; or ii) if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate at the effective
date of the modification.
The lessee should account for the remeasurement of the lease liability as follows: [IFRS 16:46]
a) for lease modifications that decrease the scope of the lease, by decreasing the carrying amount of the right-of-use asset to
reflect the partial or full termination of the lease. Any gain or loss relating to the partial or full termination of the lease should be recognised in profit or loss; and
b) for all other lease modifications, making a corresponding adjustment to the right-of-use asset.
For the lease modifications dealt with under IFRS 16:46(b), the original lease is not terminated because there is no decrease in scope. The lessee continues to have the right to use the underlying asset identified in the original lease. For lease modifications that increase the scope of a lease, the adjustment to the carrying amount of the right-of-use asset effectively represents the cost of the additional right of use acquired as a result of the modification. For lease modifications that change the consideration paid for a lease, the adjustment to the carrying amount of the right-of-use asset effectively represents a change in the cost of the right-of-use asset as a result of the modification. The use of a revised discount rate in remeasuring the lease liability reflects that, in modifying the lease, there is a change in the interest rate implicit in the lease (which the discount rate is intended to approximate). [IFRS 16:BC203(b)]
Example 7.7.3A Modification that increases the scope of the lease by extending the contractual lease term [IFRS 16:Illustrative example 16]
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, Lessee and Lessor agree to amend the original lease by extending the contractual lease term by four years. The annual lease payments are unchanged (ie 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.
Example 7.7.3B Modification that decreases the scope of the lease [IFRS 16:Illustrative example 17]
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.
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. Lessee determines the proportionate decrease in the carrying amount of the right-of-use asset on the basis of the remaining right-of-use asset (ie 2,500 square metres corresponding to 50 per cent of the original right-of-use asset).
50 per cent of the pre-modification right-of-use asset (CU184,002) is CU92,001. Fifty per cent of the pre-modification lease liability (CU210,618) is CU105,309. Consequently, Lessee reduces the carrying amount of the right-of-use asset by CU92,001 and the carrying amount of the lease liability by CU105,309.
Lessee recognises the difference between the decrease in the lease liability and the decrease in the right-of-use asset (CU105,309 – CU92,001 = CU13,308) as a gain in profit or loss at the effective date of the modification (at the beginning of Year 6).
Lessee recognises the difference between the remaining lease liability of CU105,309 and the modified lease liability of CU129,884 (which equals CU24,575) as an adjustment to the right-of-use asset reflecting the change in the consideration paid for the lease and the revised discount rate.
7.4.1.1 Right-of-use asset to be measured initially at cost At the commencement date, the right-of-use asset should be measured at cost. [IFRS 16:23]
For this purpose, cost comprises:
[IFRS 16:24]
a) the amount of the initial measurement of the lease liability, as described in IFRS 16:26 (see 7.4.2);
b) any lease payments made at or before the commencement date (see 7.3.2), less any lease incentives received (see 6.4 for a definition of
lease incentives);
c) any initial direct costs incurred by the lessee (see 7.4.1.2); and
d) an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it
is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to produce inventories. The lessee incurs the obligation for those costs either at the commencement date or as a consequence of having used the asset during a particular period (see 7.4.1.3).
See example 7.6 for an illustration of the initial and subsequent measurement of a lessee’s right-of-use asset and lease liability.
49
7.4.1.2 Initial direct costs Initial direct costs are the “[i]ncremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained, except for such costs incurred by a manufacturer or dealer lessor in connection with a finance lease”. [IFRS 16:Appendix A]
Initial direct costs are, typically, costs incurred in negotiating and securing lease arrangements. They exclude costs incurred by a lessee relating to the construction or design of an underlying asset (see 7.3.1). See 9.1.1.3 for further discussion on the nature of initial direct costs.
7.4.1.3 Restoration costs Under IFRS 16:24(d), the initial cost of a right-of-use asset includes an estimate of costs to be incurred by the lessee in dismantling and removing the underlying asset, restoring the site on which it is located or restoring the underlying asset to the condition required by the terms and conditions of the lease, unless those costs are incurred to produce inventories.
The lessee incurs the obligation for those costs either at the commencement date or as a consequence of having used the underlying asset during a particular period. [IFRS 16:24(d)]
The costs described in IFRS 16:24(d) should be recognised as part of the cost of the right-of-use asset when the lessee incurs an obligation for those costs. The lessee should apply IAS 2 Inventories to costs that are incurred during a particular period as a consequence of having used the right-of-use asset to produce inventories during that period. The obligations for such costs accounted for applying IFRS 16 or IAS 2 are recognised and measured applying IAS 37 Provisions, Contingent Liabilities and Contingent Assets. [IFRS 16:25]
At initial recognition, the estimated liability for such restoration costs is recognised as a provision under IAS 37 Provisions, Contingent Liabilities and Contingent Assets if an obligating event has already occurred. It is not included as part of the lease liability.
As a consequential amendment arising from IFRS 16, the scope of IFRIC 1 Changes in Existing Decommissioning, Restoration and Similar Liabilities has been amended to include restoration costs of this nature that are recognised as part of the cost of a right-of-use asset under IFRS 16:24(d). Therefore, any change in the entity’s estimate of such costs after initial recognition should be accounted for in accordance with that Interpretation which, for right-of-use assets measured subsequent to initial recognition using a cost model, will result in such changes being added to, or deducted from, the cost of the right-of-use asset.
Sometimes lease contracts stipulate that the underlying asset must be returned to the lessor in the same condition as when originally leased. The appropriate accounting in such circumstances depends on the particular lease clause. For example, the underlying asset may suffer general wear and tear that is merely a result of being used. In such circumstances, it may be necessary gradually to build up a provision to repair or maintain the asset over the lease term, so that it can be returned to the lessor in its original condition. Generally, in these circumstances, it would be inappropriate to recognise a provision for all of the estimated maintenance costs at the outset of the lease. Conversely, other contracts may require specific work to be performed; for example, the contract may stipulate that the asset must be painted at the end of the lease before being returned to the lessor. In such circumstances, it may be appropriate to recognise a provision at the outset of the lease because, by signing the lease contract, the entity has committed itself to painting the asset, irrespective of any wear and tear suffered.
7.4.2 Initial measurement of the lease liability
7.4.2.1 Lease liability to be measured initially at the present value of unpaid lease payments At the commencement date, the lease liability should be measured at the present value of the lease payments that are not paid at that date. [IFRS 16:26]
See section 6 for a discussion of the components of ‘lease payments’ for the purposes of this measurement.
Thinking it through In some industries, analysts have historically applied a specific multiple to operating lease expenses under IAS 17 to arrive at a proxy for the liability now being recognised under IFRS 16. For example, in the aviation industry, it has been common practice to use a multiple of seven, regardless of the outstanding term of lease arrangements. Accordingly, the liability recognised under IFRS 16 may differ significantly to the proxies previously arrived at by analysts. In such circumstances, entities will want to speak to their investors and analysts to manage expectations and avoid ‘surprises’.
The liability may also be treated as ‘debt’ for some purposes, although this will depend on the particular circumstances.
7.4.2.2 Discount rate The lease payments should be discounted using:
[IFRS 16:26]
• the interest rate implicit in the lease; or
• if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate.
The interest rate implicit in the lease is defined as “[t]he rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor”. [IFRS 16:Appendix A] The unguaranteed residual value is defined as “[t]hat portion of the residual value of the underlying asset, the realisation of which by a lessor is not assured or is guaranteed solely by a party related to the lessor". [IFRS 16:Appendix A]
The lessee’s incremental borrowing rate is defined as “[t]he rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment". [IFRS 16:Appendix A]
When the lease is denominated in a foreign currency, the lessee’s incremental borrowing rate should be the rate at which the lessee could obtain funding for the asset in the foreign currency.
The IASB’s objective in specifying the discount rate to apply to a lease is to specify a rate that reflects how the contract is priced. With this in mind, the IASB decided that, if readily determinable by the lessee, a lessee should use the interest rate implicit in the lease. [IFRS 16:BC160]
The interest rate implicit in the lease is likely to be similar to the lessee’s incremental borrowing rate in many cases. This is because both rates, as they have been defined in IFRS 16, take into account the credit standing of the lessee, the length of the lease, the nature and quality of the collateral provided and the economic environment in which the transaction occurs. However, the interest rate implicit in the lease is generally also affected by a lessor’s estimate of the residual value of the underlying asset at the end of the lease, and may be affected by taxes and other factors known only to the lessor, such as any initial direct costs of the lessor. Consequently, the IASB noted that it is likely to be difficult for lessees to determine the interest rate implicit in the lease for many leases, particularly those for which the underlying asset has a significant residual value at the end of the lease. [IFRS 16:BC161]
The IASB noted that, depending on the nature of the underlying asset and the terms and conditions of the lease, a lessee may be able to refer to a rate that is readily observable as a starting point when determining its incremental borrowing rate for a lease (e.g. the rate that a lessee has paid, or would pay, to borrow money to purchase the type of asset being leased, or the property yield when determining the discount rate to apply to property leases). Nonetheless, because the lessee’s incremental borrowing rate is defined to take into account the terms and conditions of the lease, a lessee should adjust such observable rates as needed to determine its incremental borrowing rate. [IFRS 16:BC162]
Thinking it through In attempting to arrive at an appropriate discount rate, some lessees may decide to approach lessors in order to obtain greater insight into the pricing of contracts and returns being made by lessors. In some industries and for some lessors, this may not be sensitive information and the lessors may readily provide it. In other cases, lessors may be reluctant to divulge such information for commercial reasons and lessees will need to consider whether the implicit rate is readily determinable by other means, before resorting to the incremental borrowing rate.
7.5 Subsequent measurement
7.5.1 Subsequent measurement of the right-of-use asset
7.5.1.1 Subsequent measurement of the right-of-use asset – general After the commencement date, the right-of-use asset should be measured using a cost model (see 7.5.1.2), unless it applies either of the measurement models described in IFRS 16:34 and 35 (see 7.5.1.5 and 7.5.1.6, respectively). [IFRS 16:29]
7.5.1.2 Cost model for right-of-use assets Under the cost model, the right-of-use asset is measured at cost:
[IFRS 16:30]
• less any accumulated depreciation and any accumulated impairment losses (see 7.5.1.3 and 7.5.1.4, respectively); and
• adjusted for any remeasurement of the lease liability specified in IFRS 16:36(c) (see 7.5.2.1).
7.5.1.3 Depreciation for right-of-use assets Right-of-use assets measured under the cost model should be depreciated in accordance with the depreciation requirements in IAS 16, subject to the following:
[IFRS 16:31 & 32]
• if the lease transfers ownership of the underlying asset to the lessee by the end of the lease term, or if the cost of the right-of-use asset reflects that the lessee will exercise a purchase option, the right-of-use asset should be depreciated from the commencement date to the end of the useful life of the underlying asset;
• otherwise, the right-of-use asset should be depreciated from the commencement date to the earlier of the end of the useful life of the right-of-use asset and the end of the lease term.
The useful life of an asset is defined as “[t]he period over which an asset is expected to be available for use by an entity; or the number of production or similar units expected to be obtained from an asset by an entity”. [IFRS 16:Appendix A]
Therefore, if the ownership of the underlying asset transfers to the lessee at the end of the lease term, or it is reasonably certain that the lessee will exercise a purchase option, depreciation is based on the useful life of the underlying asset. Otherwise, depreciation is determined by reference to the useful life of the right-of-use asset (provided that is not longer than the lease term).
7.5.1.4 Impairment for right-of-use assets A lessee should apply IAS 36 Impairment of Assets to determine whether the right-of-use asset is impaired and to account for any impairment loss identified. [IFRS 16:33]
7.5.1.5 Right-of-use assets that meet the definition of investment property If a lessee applies the fair value model in IAS 40 Investment Property to its investment property, it is also required to apply that fair value model to right-of-use assets that meet the definition of investment property in IAS 40. [IFRS 16:34]
IFRS 16 has amended the scope of IAS 40 by defining investment property to include both owned investment property and investment property held by a lessee as a right-of-use asset. A lessee is required to account for right-of-use assets that meet the definition of investment property in a manner consistent with its policy for owned investment property – i.e. using either the cost model and disclosing fair value, or using the fair value model. [IFRS 16:BC178]
7.5.1.6 Right-of-use assets that relate to a class of revalued property, plant and equipment If right-of-use assets relate to a class of property, plant and equipment to which the lessee applies the revaluation model in IAS 16, a lessee may elect to apply that revaluation model to all of the right-of-use assets that relate to that class of property, plant and equipment. [IFRS 16:35]
Therefore, for property, plant and equipment:
• if the class of owned assets to which right-of-assets relate is measured using the cost model, the right-of-use assets should also be accounted for using the cost model; but
• if the class of assets to which right-of-use assets relate is measured using IAS 16’s revaluation model, a lessee can chose whether to measure right-of-use assets at fair value. This choice is made on a class-by-class basis. This is in contrast to right-of-use assets that meet the definition of investment property for which the accounting model to be followed is determined by the lessee’s accounting policy for owned investment property (see 7.5.1.5).
7.5.2 Subsequent measurement of the right-of-use liability
7.5.2.1 Subsequent measurement of the lease liability – general After the commencement date, the lease liability should be measured by:
[IFRS 16:36]
a) increasing the carrying amount to reflect interest on the lease liability;
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 in IFRS 16:39 to 46 (see 7.5.2.4), or to
reflect revised in-substance fixed lease payments (see 6.3).
Lease liabilities are measured on an ongoing basis similarly to other financial liabilities, using an effective interest method, so that the carrying amount of the lease liability is measured on an amortised cost basis and the interest expense is allocated over the lease term. IFRS 16 does not require or permit a lessee to measure lease liabilities at fair value after initial measurement. [IFRS 16:BC182 & BC183]
Thinking it through Accounting systems will need to be able to cater for scenarios where remeasurement of the liability is required, potentially with an updated discount rate. Basic spreadsheet solutions may struggle to cope with such demands as well as identifying when such remeasurements are required.
7.5.2.2 Recognising interest on the lease liability Interest on the lease liability in each period during the lease term should be the amount that produces a constant periodic rate of interest on the remaining balance of the lease liability. For this purposes, the periodic rate of interest is the discount rate used in the initial measurement of the lease liability (see 7.4.2.2) or, if applicable, the revised discount rate described in IFRS 16:41 or 43 (see 7.5.2.5 to 7.5.2.7) or IFRS 16:45(c) (see 7.7.3). [IFRS 16:37]
7.5.2.3 Amounts to be recognised in profit or loss After the commencement date, a lessee should recognise in profit or loss (unless the costs are included in the carrying amount of another asset under other applicable IFRSs), both:
[IFRS 16:38]
• interest on the lease liability; and
• 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 (see also 6.5.3).
Thinking it through Because the interest expense on the lease liability will be front-loaded, this leads to an overall front-loading of the expense when combined with straight-line depreciation of the right-of-use asset. This means that, for an individual lease, the expense will typically be higher in the earlier years (compared to the previous IAS 17 expense) and lower in the later years. However, when an entity has a portfolio of leases of varying maturities which are renewed on a rolling basis, the overall effect may still resemble an approximately straight-line expense, similar to that reported under IAS 17.
Recognising an interest and depreciation expense under IFRS 16, rather than an operating expense for rentals paid under IAS 17, means that metrics such as EBITDA will increase compared to amounts reported when IAS 17 is applied. This may have a knock-on effect on an entity’s KPIs, bonus targets, contingent consideration arrangements, lending covenants and more.
7.5.2.4 Remeasurement of the lease liability – general After the commencement date, if changes to the lease payments occur, the lease liability should be remeasured in accordance with IFRS 16:40 to 43 (see 7.5.2.5 to 7.5.2.7). The amount of the remeasurement of the lease liability should generally be recognised as an adjustment to the right-of-use asset (see 7.5.1.2). 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, the remaining remeasurement should be recognised in profit or loss. [IFRS 16:39]
7.5.2.5 Remeasurements arising from a change in the lease term or reassessment of purchase option The lease liability should be remeasured by discounting the revised lease payments using a revised discount rate, if either:
[IFRS 16:40]
• there is a change in the lease term (see 5.7 and 5.8), in which case the revised lease payments should be determined on the basis of the revised lease term; or
• there is a change in the assessment of an option to purchase the underlying asset, assessed considering the events and circumstances described in IFRS 16:20 and 21 (see 5.7 and 5.8) in the context of a purchase option, in which case the revised lease payments should be determined to reflect the change in amounts payable under the purchase option.
In most cases, an entity should not reassess the discount rate during the lease term. However, IFRS 16 requires a lessee to remeasure the lease liability using revised payments and a revised discount rate when there is a change in the lease term or a change in the assessment of whether the lessee is reasonably certain to exercise an option to purchase the underlying asset. In the IASB’s view, in those circumstances, the economics of the lease have changed and it is appropriate to reassess the discount rate to be consistent with the change in the lease payments included in the measurement of the lease liability (and right-of-use asset). [IFRS 16:B193 & BC194]
In applying IFRS 16:40, the revised discount rate used should be:
[IFRS 16:41]
• the interest rate implicit in the lease for the remainder of the lease term; or
• if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate at the date of reassessment.
7.5.2.6 Remeasurements arising from a change in the amounts expected to be payable under a residual value guarantee The lease liability should be remeasured by discounting the revised lease payments (i.e. reflecting the change in the residual value guarantee) using an unchanged discount rate, unless the change in the residual value guarantee results from a change in floating interest rates, in which case the lessee should use a revised discount rate that reflects changes in the interest rate. [IFRS 16:42(a) & 43]
7.5.2.7 Remeasurements arising from a change in future lease payments resulting from a change in an index or a rate These requirements apply when 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). In such circumstances, the lease liability should be remeasured 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 – see example 7.5.2.7). [IFRS 16:42(b)]
The IASB decided that a lessee should reassess variable lease payments that are determined by reference to an index or a rate only when there is a change in the cash flows resulting from a change in the reference index or rate. This approach is considered to be less complex and costly to apply than requiring a lessee to reassess variable lease payments at each reporting date. [IFRS 16:BC190]
The revised lease payments for the remainder of the lease term should be determined based on the revised contractual payments. They should be discounted using an unchanged discount rate, unless the change in the lease payments results from a change in floating interest rates, in which case the lessee should use a revised discount rate that reflects changes in the interest rate. [IFRS 16:42(b) & 43]
IFRS 16 generally does not permit an entity to reassess the discount rate during the lease term. An exception is made when there is a change in the lease term or a change in the assessment regarding a purchase option (see 7.5.2.5). The IASB also decided that, in a floating interest rate lease, a lessee should use a revised discount rate to remeasure the lease liability when there is a change in lease payments resulting from changes in the floating interest rate. This approach is consistent with the requirements in IFRS 9 Financial Instruments for the measurement of floating-rate financial liabilities subsequently measured at amortised cost. [IFRS 16:BC195]
Example 7.5.2.7
Remeasurements arising from a change in future lease payments resulting from a change in an index On 1 January 20X1, Entity A leases a property for a lease term of 8 years. The lease payments for the first three years have been agreed at CU100 per year. The lease payments will be reset on 1 January 20X4 (and, subsequently, on 1 January 20X7) on the basis of the increase in the Retail Price Index (RPI) for the preceding three years. All lease payments are made at the end of the relevant year.
At 1 January 20X1 (the commencement date), the RPI is 100 and Entity A measures its lease liability at CU646 (8 payments of CU100 payable in arrears, discounted at the interest rate implicit in the lease of 5 per cent).
On 1 January 20X2, 20X3 and 20X4, respectively, the RPI is 103, 107 and 108. On 1 January 20X7, the RPI is 113.
In its financial statements for the years ended 31 December 20X1, 31 December 20X2 and 31 December 20X3, Entity A makes no adjustment for increases in RPI because there is no change in cash flows in those years. In its financial statements for year ended 31 December 20X4 (and subsequently 20X7), Entity A recalculates its liability based on the increased RPI. These adjustments are added to the carrying amount of the lease liability and the related right-of-use asset, subject to the requirements of IFRS 16:39 (see 7.5.2.4).
a) Difference between five remaining payments of CU100 discounted at 5 per cent and five remaining payments of CU108 discounted
at 5 per cent.
b) Difference between two remaining payments of CU108 discounted at 5 per cent and two remaining payments of CU113 discounted
at 5 per cent.
7.5.2.8 Foreign currency exchange
IFRS 16 does not provide specific requirements as to how a lessee should account for the effects of foreign currency exchange differences relating to lease liabilities that are denominated in a foreign currency. In line with other financial liabilities, a lessee’s lease liability is a monetary item and consequently, if denominated in a foreign currency, is required to be remeasured using closing rates at the end of each reporting period applying IAS 21 The Effects of Changes in Foreign Exchange Rates. Such foreign exchange differences are recognised in profit in loss and not as an adjustment to the carrying amount of the right-of-use asset. [IFRS 16:BC196 – BC198]
7.6 Illustrative example – lessee measurement The following example, reproduced from the illustrative examples accompanying IFRS 16, illustrates how a lessee measures right-of-use assets and lease liabilities. It also illustrates how a lessee accounts for a change in the lease term.
Example 7.6 Measurement by a lessee and accounting for a change in the lease term [IFRS 16:Illustrative example 13]
Part 1 – Initial measurement of the right-of-use asset and the lease liability
Lessee enters into a 10-year lease of a floor of a building, with an option to extend for five years. Lease payments are CU50,000 per year during the initial term and CU55,000 per year during the optional period, all payable at the beginning of each year. To obtain the lease, Lessee incurs initial direct costs of CU20,000, of which CU15,000 relates to a payment to a former tenant occupying that floor of the building and CU5,000 relates to a commission paid to the real estate agent that arranged the lease. As an incentive to Lessee for entering into the lease, Lessor agrees to reimburse to Lessee the real estate commission of CU5,000 and Lessee’s leasehold improvements of CU7,000.
At the commencement date, Lessee concludes that it is not reasonably certain to exercise the option to extend the lease and, therefore, determines that the lease term is 10 years.
The interest rate implicit in the lease is not readily determinable. Lessee’s incremental borrowing rate is 5 per cent per annum, which reflects the fixed rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a 10-year term, and with similar collateral.
At the commencement date, Lessee makes the lease payment for the first year, incurs initial direct costs, receives lease incentives from Lessor and measures the lease liability at the present value of the remaining nine payments of CU50,000, discounted at the interest rate of 5 per cent per annum, which is CU355,391.
Lessee initially recognises assets and liabilities in relation to the lease as follows.
Right-of-use asset CU405,391
Lease liability CU355,391
Cash (lease payment for the first year) CU50,000
Right-of-use asset CU20,000
Cash (initial direct costs) CU20,000
Cash (lease incentive) CU5,000
Right-of-use asset CU5,000
Lessee accounts for the reimbursement of leasehold improvements from Lessor applying other relevant Standards and not as a lease incentive applying IFRS 16. This is because costs incurred on leasehold improvements by Lessee are not included within the cost of the right-of-use asset.
Part 2 – Subsequent measurement and accounting for a change in the lease term
In the sixth year of the lease, Lessee acquires Entity A. Entity A has been leasing a floor in another building. The lease entered into by Entity A contains a termination option that is exercisable by Entity A. Following the acquisition of Entity A, Lessee needs two floors in a building suitable for the increased workforce. To minimise costs, Lessee (a) enters into a separate eight-year lease of another floor in the building leased that will be available for use at the end of Year 7 and (b) terminates early the lease entered into by Entity A with effect from the beginning of Year 8.
Moving Entity A’s staff to the same building occupied by Lessee creates an economic incentive for Lessee to extend its original lease at the end of the non-cancellable period of 10 years. The acquisition of Entity A and the relocation of Entity A’s staff is a significant event that is within the control of Lessee and affects whether Lessee is reasonably certain to exercise the extension option not previously included in its determination of the lease term. This is because the original floor has greater utility (and thus provides greater benefits) to Lessee than alternative assets that could be leased for a similar amount to the lease payments for the optional period – Lessee would incur additional costs if it were to lease a similar floor in a different building because the workforce would be located in different buildings. Consequently, at the end of Year 6, Lessee concludes that it is now reasonably certain to exercise the option to extend its original lease as a result of its acquisition and planned relocation of Entity A.
Lessee’s incremental borrowing rate at the end of Year 6 is 6 per cent per annum, which reflects the fixed rate at which Lessee could borrow an amount similar to the value of the right-of-use asset, in the same currency, for a nine-year term, and with similar collateral. Lessee expects to consume the right-of-use asset’s future economic benefits evenly over the lease term and, thus, depreciates the right-of-use asset on a straight-line basis.
At the end of the sixth year, before accounting for the change in the lease term, the lease liability is CU186,162 (the present value of four remaining payments of CU50,000, discounted at the original interest rate of 5 per cent per annum). Interest expense of CU8,865 is recognised in Year 6. Lessee’s right-of-use asset is CU168,157.
Lessee remeasures the lease liability at the present value of four payments of CU50,000 followed by five payments of CU55,000, all discounted at the revised discount rate of 6 per cent per annum, which is CU378,174. Lessee increases the lease liability by CU192,012, which represents the difference between the remeasured liability of CU378,174 and its previous carrying amount of CU186,162. The corresponding adjustment is made to the right-of-use asset to reflect the cost of the additional right of use, recognised as follows.
Right-of-use asset CU192,012
Lease liability CU192,012
Following the remeasurement, the carrying amount of Lessee’s right-of-use asset is CU360,169 (ie CU168,157 + CU192,012). From the beginning of Year 7 Lessee calculates the interest expense on the lease liability at the revised discount rate of 6 per cent per annum.
7.7 Lease modifications 7.7.1 Lease modification – definition A ‘lease modification’ is defined as “[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]
The ‘effective date of the modification’ is “[t]he date when both parties agree to a lease modification”. [IFRS 16:Appendix A] 60Lease payment
5% interest expense
Ending balance
Beginning balance
Depreciation charge
7.7.2 Conditions for treating a lease modification as a separate lease A lease modification should be accounted for as a separate lease if both of the following apply:
[IFRS 16:44]
• 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 by an amount commensurate with the stand-alone price for the increase in scope and any appropriate adjustments to that stand-alone price to reflect the circumstances of the particular contract.
When the conditions in IFRS 16:44 are met, the modification is considered to result in the creation of a new lease that is separate from the original lease. [IFRS 16:BC202] The agreement for the right to use one or more additional assets is accounted for as a separate lease (or leases) to which the requirements of IFRS 16 are applied independently of the original lease.
The following example, reproduced from the illustrative examples accompanying IFRS 16, illustrates a modification that should be accounted for as a separate lease.
Example 7.7.2 Measurement by a lessee and accounting for a change in the lease term [IFRS 16:Illustrative example 15]
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.
7.7.3 Lease modifications that are not accounted for as 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 should:
[IFRS 16:45]
a) allocate the consideration in the modified contract applying the requirements of IFRS 16: 13 to 16 (see 4.2);
b) determine the lease term of the modified lease applying the requirements of IFRS 16:18 and 19 (see section 5); and
c) remeasure the lease liability by discounting the revised lease payments using a revised discount rate. The revised discount rate
is determined as:
i) the interest rate implicit in the lease for the remainder of the lease term; or ii) if the interest rate implicit in the lease cannot be readily determined, the lessee’s incremental borrowing rate at the effective
date of the modification.
The lessee should account for the remeasurement of the lease liability as follows: [IFRS 16:46]
a) for lease modifications that decrease the scope of the lease, by decreasing the carrying amount of the right-of-use asset to
reflect the partial or full termination of the lease. Any gain or loss relating to the partial or full termination of the lease should be recognised in profit or loss; and
b) for all other lease modifications, making a corresponding adjustment to the right-of-use asset.
For the lease modifications dealt with under IFRS 16:46(b), the original lease is not terminated because there is no decrease in scope. The lessee continues to have the right to use the underlying asset identified in the original lease. For lease modifications that increase the scope of a lease, the adjustment to the carrying amount of the right-of-use asset effectively represents the cost of the additional right of use acquired as a result of the modification. For lease modifications that change the consideration paid for a lease, the adjustment to the carrying amount of the right-of-use asset effectively represents a change in the cost of the right-of-use asset as a result of the modification. The use of a revised discount rate in remeasuring the lease liability reflects that, in modifying the lease, there is a change in the interest rate implicit in the lease (which the discount rate is intended to approximate). [IFRS 16:BC203(b)]
Example 7.7.3A Modification that increases the scope of the lease by extending the contractual lease term [IFRS 16:Illustrative example 16]
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, Lessee and Lessor agree to amend the original lease by extending the contractual lease term by four years. The annual lease payments are unchanged (ie 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.
Example 7.7.3B Modification that decreases the scope of the lease [IFRS 16:Illustrative example 17]
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.
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. Lessee determines the proportionate decrease in the carrying amount of the right-of-use asset on the basis of the remaining right-of-use asset (ie 2,500 square metres corresponding to 50 per cent of the original right-of-use asset).
50 per cent of the pre-modification right-of-use asset (CU184,002) is CU92,001. Fifty per cent of the pre-modification lease liability (CU210,618) is CU105,309. Consequently, Lessee reduces the carrying amount of the right-of-use asset by CU92,001 and the carrying amount of the lease liability by CU105,309.
Lessee recognises the difference between the decrease in the lease liability and the decrease in the right-of-use asset (CU105,309 – CU92,001 = CU13,308) as a gain in profit or loss at the effective date of the modification (at the beginning of Year 6).
Lessee recognises the difference between the remaining lease liability of CU105,309 and the modified lease liability of CU129,884 (which equals CU24,575) as an adjustment to the right-of-use asset reflecting the change in the consideration paid for the lease and the revised discount rate.
Example 7.7.3C Modification that both increases and decreases the scope of the lease [IFRS 16:Illustrative example 18]
Lessee enters into a 10-year lease for 2,000 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 6, Lessee and Lessor agree to amend the original lease to (a) include an additional 1,500 square metres of space in the same building starting from the beginning of Year 6 and (b) reduce the lease term from 10 years to eight years. The annual fixed payment for the 3,500 square metres is CU150,000 payable at the end of each year (from Year 6 to Year 8). Lessee’s incremental borrowing rate at the beginning of Year 6 is 7 per cent per annum.
The consideration for the increase in scope of 1,500 square metres of space is not commensurate with the stand-alone price for that increase adjusted to reflect the circumstances of the contract. Consequently, Lessee does not account for the increase in scope that adds the right to use an additional 1,500 square metres of space as a separate lease.
At the effective date of the modification (at the beginning of Year 6), Lessee remeasures the lease liability on the basis of: (a) a three-year remaining lease term, (b) annual payments of CU150,000 and (c) Lessee’s incremental borrowing rate of 7 per cent per annum. The modified liability equals CU393,647, of which (a) CU131,216 relates to the increase of CU50,000 in the annual lease payments from Year 6 to Year 8 and (b) CU262,431 relates to the remaining three annual lease payments of CU100,000 from Year 6 to Year 8.
Decrease in the lease term At the effective date of the modification (at the beginning of Year 6), the pre-modification right-of-use asset is CU368,004. Lessee determines the proportionate decrease in the carrying amount of the right-of-use asset based on the remaining right-of-use asset for the original 2,000 square metres of office space (ie a remaining three-year lease term rather than the original five-year lease term). The remaining right-of-use asset for the original 2,000 square metres of office space is CU220,802 (ie CU368,004 ÷ 5 × 3 years).
At the effective date of the modification (at the beginning of Year 6), the pre-modification lease liability is CU421,236. The remaining lease liability for the original 2,000 square metres of office space is CU267,301 (ie present value of three annual lease payments of CU100,000, discounted at the original discount rate of 6 per cent per annum). 646% interest expense
Lease payment
Ending balance
Beginning balance
Depreciation charge
Leases | A guide to IFRS 16
Consequently, Lessee reduces the carrying amount of the right-of-use asset by CU147,202 (CU368,004 – CU220,802), and the carrying amount of the lease liability by CU153,935 (CU421,236 – CU267,301). Lessee recognises the difference between the decrease in the lease liability and the decrease in the right-of-use asset (CU153,935 – CU147,202 = CU6,733) as a gain in profit or loss at the effective date of the modification (at the beginning of Year 6).
Lease liability CU153,935
Right-of-use asset CU147,202
Gain CU6,733
At the effective date of the modification (at the beginning of Year 6), Lessee recognises the effect of the remeasurement of the remaining lease liability reflecting the revised discount rate of 7 per cent per annum, which is CU4,870 (CU267,301 – CU262,431), as an adjustment to the right-of-use asset.
Lease liability CU4,870
Right-of-use asset CU4,870
Increase in the leased space At the commencement date of the lease for the additional 1,500 square metres of space (at the beginning of Year 6), Lessee recognises the increase in the lease liability related to the increase in scope of CU131,216 (ie present value of three annual lease payments of CU50,000, discounted at the revised interest rate of 7 per cent per annum) as an adjustment to the right-of-use asset.
Right-of-use asset CU131,216
Lease liability CU131,216
Example 7.7.3D Modification that is a change in consideration only [IFRS 16:Illustrative example 19]
Lessee enters into a 10-year lease for 5,000 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 reduce the lease payments from CU100,000 per year to CU95,000 per 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. Lessee’s incremental borrowing rate at the beginning of Year 6 is 7 per cent per annum. The annual lease payments are payable at the end of each year.
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 CU95,000 and (c) Lessee’s incremental borrowing rate of 7 per cent per annum. Lessee recognises the difference between the carrying amount of the modified liability (CU389,519) and the lease liability immediately before the modification (CU421,236) of CU31,717 as an adjustment to the right-of-use asset.
Lessee enters into a 10-year lease for 2,000 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 6, Lessee and Lessor agree to amend the original lease to (a) include an additional 1,500 square metres of space in the same building starting from the beginning of Year 6 and (b) reduce the lease term from 10 years to eight years. The annual fixed payment for the 3,500 square metres is CU150,000 payable at the end of each year (from Year 6 to Year 8). Lessee’s incremental borrowing rate at the beginning of Year 6 is 7 per cent per annum.
The consideration for the increase in scope of 1,500 square metres of space is not commensurate with the stand-alone price for that increase adjusted to reflect the circumstances of the contract. Consequently, Lessee does not account for the increase in scope that adds the right to use an additional 1,500 square metres of space as a separate lease.
At the effective date of the modification (at the beginning of Year 6), Lessee remeasures the lease liability on the basis of: (a) a three-year remaining lease term, (b) annual payments of CU150,000 and (c) Lessee’s incremental borrowing rate of 7 per cent per annum. The modified liability equals CU393,647, of which (a) CU131,216 relates to the increase of CU50,000 in the annual lease payments from Year 6 to Year 8 and (b) CU262,431 relates to the remaining three annual lease payments of CU100,000 from Year 6 to Year 8.
Decrease in the lease term At the effective date of the modification (at the beginning of Year 6), the pre-modification right-of-use asset is CU368,004. Lessee determines the proportionate decrease in the carrying amount of the right-of-use asset based on the remaining right-of-use asset for the original 2,000 square metres of office space (ie a remaining three-year lease term rather than the original five-year lease term). The remaining right-of-use asset for the original 2,000 square metres of office space is CU220,802 (ie CU368,004 ÷ 5 × 3 years).
At the effective date of the modification (at the beginning of Year 6), the pre-modification lease liability is CU421,236. The remaining lease liability for the original 2,000 square metres of office space is CU267,301 (ie present value of three annual lease payments of CU100,000, discounted at the original discount rate of 6 per cent per annum). 646% interest expense
Lease payment
Ending balance
Beginning balance
Depreciation charge
Leases | A guide to IFRS 16
Consequently, Lessee reduces the carrying amount of the right-of-use asset by CU147,202 (CU368,004 – CU220,802), and the carrying amount of the lease liability by CU153,935 (CU421,236 – CU267,301). Lessee recognises the difference between the decrease in the lease liability and the decrease in the right-of-use asset (CU153,935 – CU147,202 = CU6,733) as a gain in profit or loss at the effective date of the modification (at the beginning of Year 6).
Lease liability CU153,935
Right-of-use asset CU147,202
Gain CU6,733
At the effective date of the modification (at the beginning of Year 6), Lessee recognises the effect of the remeasurement of the remaining lease liability reflecting the revised discount rate of 7 per cent per annum, which is CU4,870 (CU267,301 – CU262,431), as an adjustment to the right-of-use asset.
Lease liability CU4,870
Right-of-use asset CU4,870
Increase in the leased space At the commencement date of the lease for the additional 1,500 square metres of space (at the beginning of Year 6), Lessee recognises the increase in the lease liability related to the increase in scope of CU131,216 (ie present value of three annual lease payments of CU50,000, discounted at the revised interest rate of 7 per cent per annum) as an adjustment to the right-of-use asset.
Right-of-use asset CU131,216
Lease liability CU131,216
Example 7.7.3D Modification that is a change in consideration only [IFRS 16:Illustrative example 19]
Lessee enters into a 10-year lease for 5,000 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 reduce the lease payments from CU100,000 per year to CU95,000 per 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. Lessee’s incremental borrowing rate at the beginning of Year 6 is 7 per cent per annum. The annual lease payments are payable at the end of each year.
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 CU95,000 and (c) Lessee’s incremental borrowing rate of 7 per cent per annum. Lessee recognises the difference between the carrying amount of the modified liability (CU389,519) and the lease liability immediately before the modification (CU421,236) of CU31,717 as an adjustment to the right-of-use asset.
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