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 by adding the right to use one or more underlying assets
- The increase in consideration is commensurate with the standalone price for that 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
For a modification accounted for as a separate lease, the new lease is measured using the discount rate at the commencement date of that separate lease. For modifications not accounted for as a separate lease, the lessee remeasures the existing lease liability using a revised discount rate at the effective date of the modification.
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 £50,000 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 increase in consideration is commensurate with the 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 and Lease Liability
Reduce the carrying amounts of both the ROU asset and the lease liability by the proportion of the right of use that has been terminated (for example, 25% if a quarter of the space is returned).
Recognise Gain or Loss
Any difference between the proportional reduction in the ROU asset and the proportional reduction in the lease liability is recognised in profit or loss.
Remeasure the Remaining Lease Liability
Remeasure the remaining lease liability using the revised lease payments and a revised discount rate at the modification date. The adjustment is taken to the ROU asset, with no further P&L impact.
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 after remeasurement (remaining 75% of space, at revised discount rate): £300,000
| Step | Calculation | Amount |
|---|---|---|
| Step 1: ROU asset reduction | £400,000 × 25% | £100,000 |
| Step 1: Lease liability reduction | £380,000 × 25% | £95,000 |
| Step 2: Loss on partial termination | £100,000 − £95,000 | £5,000 |
| Step 3: Remeasurement adjustment | £300,000 − (£380,000 − £95,000) | £15,000 |
Net effect: the ROU asset is reduced by £85,000, the lease liability is reduced by £80,000, and £5,000 is recognised as a loss in profit or loss.
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
This example assumes the term extension is a contractual change agreed between the parties (a modification under IFRS 16.44), not a reassessment of an existing extension option that was previously not reasonably certain to be exercised. A change in assessment of an option follows the remeasurement guidance (see remeasurement).
Scenario
A company and lessor agree to extend the lease by 3 years at the start of Year 3:
- Lease liability before modification: £370,000
- Revised lease liability (new 5-year term at revised discount 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 the ROU asset (including accumulated depreciation), the lease liability, and recognises 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 cost: £500,000
- Accumulated depreciation: £320,000
- ROU asset net book value: £180,000
- Lease liability carrying amount: £200,000
- Termination payment: £50,000
Loss calculation: Net 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 + consideration increase commensurate with standalone price) | Rate at commencement of new lease | No (new lease only) |
| Decrease in scope (partial termination) | Revised rate | Yes (gain/loss on modification date) |
| Other modifications (term extension, negotiated payment changes) | Revised rate | No immediate gain/loss. Future depreciation and interest will change |
| Full termination | No remeasurement; settlement terms affect gain/loss | 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 (e.g. index-linked changes use the original rate; option reassessments use a revised rate)
- 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.