Key Takeaways
- A modification is a change to the terms of a lease contract (vs remeasurement which is an estimate change)
- Modifications can be accounted for as a separate lease or as a change to the existing lease
- Scope increases at standalone prices are treated as separate leases
- Scope decreases require proportional derecognition of the ROU asset with a gain/loss
- All modifications (except separate leases) use a revised discount rate at the modification date
What is a Lease Modification?
A lease modification is a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions. This is different from a remeasurement, which adjusts for changes in estimates or assessments.
IFRS 16 Definition
"A lease modification is a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions of the lease."
- IFRS 16 Appendix A
Common Modification Examples
- Extending or reducing the contractual lease term
- Adding or removing leased space
- Changing the lease payments (not index-linked changes)
- Adding or removing equipment from an equipment lease
Modification Decision Framework
When a lease is modified, the first question is whether to account for it as a separate lease or as a modification to the existing lease.
Is it a Separate Lease?
A modification is accounted for as a separate lease if both conditions are met:
- The modification increases the scope (adds right to use additional assets)
- The additional consideration is commensurate with the standalone price for the increase in scope
If Not a Separate Lease
Account for the modification as a change to the existing lease. The accounting depends on whether the modification:
- Decreases the scope of the lease
- Is any other type of modification
Key Principle
Unlike remeasurements, all modifications (that are not separate leases) require using a revised discount rate determined at the modification effective date.
Accounting as a Separate Lease
When a modification qualifies as a separate lease, the additional right-of-use is accounted for separately from the original lease. The original lease continues unchanged.
Scenario: Separate Lease
A company leases 1,000 sqm of office space for £100,000 per year. Two years in, they negotiate to lease an additional 500 sqm for £55,000 per year (which is the current market rate for that space). This is a separate lease because:
- It adds right to use additional space (increases scope)
- The price is at market rate (commensurate with standalone price)
The original 1,000 sqm lease continues with its original terms. The new 500 sqm is accounted for as a brand new lease, with its own ROU asset and lease liability measured at the modification date.
Decrease in Scope
When a modification decreases the scope of a lease (e.g., partial termination, returning space), the accounting involves three steps:
Proportionally Reduce the ROU Asset
Decrease the carrying amount of the ROU asset to reflect the partial termination. The reduction is based on the proportion of the right of use that has been terminated.
Remeasure the Lease Liability
Recalculate the lease liability using the revised lease payments and a revised discount rate at the modification date.
Recognise Gain or Loss
Any difference between the reduction in the ROU asset and the reduction in the lease liability is recognised as a gain or loss in profit or loss.
Worked Example: Partial Termination
Scenario
A company returns 25% of its leased space midway through the lease:
- ROU asset carrying amount before modification: £400,000
- Lease liability before modification: £380,000
- Revised lease liability (remaining 75% of space): £300,000
| Step | Calculation | Amount |
|---|---|---|
| ROU asset reduction | £400,000 × 25% | £100,000 |
| Lease liability reduction | £380,000 − £300,000 | £80,000 |
| Loss on modification | £100,000 − £80,000 | £20,000 |
Other Modifications
For modifications that don't qualify as a separate lease and don't decrease scope (e.g., lease term extensions, rent changes), the accounting is simpler:
- Remeasure the lease liability using revised payments and a revised discount rate
- Adjust the ROU asset by the same amount (no P&L impact)
Worked Example: Term Extension
Scenario
A company extends its lease by 3 years at the start of Year 3:
- Lease liability before modification: £370,000
- Revised lease liability (new 5-year term at 5% rate): £450,000
- ROU asset before modification: £340,000
The revised ROU asset of £420,000 is then depreciated over the remaining 5-year term.
Full Early Termination
When a lease is terminated before its originally scheduled end date, the lessee derecognises both the ROU asset and lease liability, recognising any difference as a gain or loss.
Worked Example: Early Termination
Scenario
A company terminates a lease early, paying a termination penalty of £50,000:
- ROU asset net book value: £180,000
- Lease liability carrying amount: £200,000
- Termination payment: £50,000
Loss calculation: Asset derecognised (£180,000) + payment (£50,000) − liability derecognised (£200,000) = £30,000 loss
Modification Summary
| Modification Type | Discount Rate | P&L Impact |
|---|---|---|
| Separate lease (scope increase at market rate) | New rate for new lease | No |
| Decrease in scope (partial termination) | Revised rate | Yes (gain/loss) |
| Other modifications (term extension, rent change) | Revised rate | No |
| Full termination | N/A | Yes (gain/loss) |
Modifications vs Remeasurements
It's important to distinguish between modifications and remeasurements:
Modification
- Change to the contract terms
- Always uses revised discount rate
- May result in gain/loss
Example: Negotiated lease extension
Remeasurement
- Change in estimates or assessments
- May use original or revised rate (depends on trigger)
- No gain/loss (unless ROU asset goes negative)
Example: Reassessing option exercise likelihood
For detailed remeasurement guidance, see our Remeasurement guide.
This article is provided for general informational purposes only and does not constitute accounting, legal or professional advice.