IFRS 16 defines a lease modification 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, and it sets out two different treatments for a lessee depending on the nature of that change.
First Case: Accounting for the Modification as a Separate Lease
A lessee accounts for a lease modification as a separate lease if both of the following conditions are met:
- The modification increases the scope of the lease by adding the right to use one or more underlying assets.
- The consideration for the lease increases by an amount commensurate with the stand-alone price for the increase in scope, with any appropriate adjustments to reflect the circumstances of the particular contract.
In this case, the added portion of the contract is treated as a new lease that is entirely separate from the original contract, without remeasuring the existing lease liability or right-of-use asset.
Second Case: A Modification Not Accounted for as a Separate Lease
For modifications that do not meet both conditions above, the lessee, at the effective date of the modification:
- Allocates the consideration in the modified contract applying the requirements for allocating consideration among contract components.
- Redetermines the lease term of the modified lease.
- Remeasures the lease liability by discounting the revised lease payments using a revised discount rate, determined as the interest rate implicit in the lease for the remainder of the lease term if that rate can be readily determined, or otherwise the lessee's incremental borrowing rate at the effective date of the modification.
Effect of Remeasurement on the Right-of-Use Asset
When the lease liability is remeasured as a result of a modification that is not accounted for as a separate lease, the lessee generally adjusts the carrying amount of the right-of-use asset by the amount of the change in the lease liability, so that the financial statements reflect the new terms of the contract without restarting the transaction from scratch.
Common Examples of Lease Modifications
Common modifications a lessee encounters include extending or shortening the lease term, adding further leased space in the same building or at another location, and changing the agreed lease payments following renegotiation between the parties. In each case, the lessee needs to determine whether any increase in scope is accompanied by consideration commensurate with its stand-alone price before deciding which of the two accounting paths applies to the modification, since that decision makes the difference between recognising an entirely new, separate lease and remeasuring the existing lease using a revised discount rate.
Legal References
- IFRS 16 — Leases, paragraph 44 (conditions for treating a modification as a separate lease).
- IFRS 16, paragraph 45 (accounting when the modification is not a separate lease).
- IFRS Glossary of Terms (definition of a lease modification — IFRS 16.A).
For questions about your specific situation, you can ask the Accounting Helper (private sector) on Helpers, or consult a licensed chartered accountant.