Introduction
In the previous guide we discussed how to account for the transactions required after the lease commenced, but now we will look at leases changing during that period.
Whenever there is a change in the contract or even your own internal estimates changed, then the liability must be adjusted. For instance, if you initially thought that you will not renew the contract, but after the start of lease you realized you will, then you have to update the lease calculation and account for the change.
Any contractual change will usually require you to account for it as a modification. Any cash flow changes or estimate reassessments will be accounted for as a remeasurement.
In both type of changes, you will determine the updated lease payments, consider the appropriate discount rate to use and recalculate the present value. You will compare the new present value with the current lease liability and this ‘lease difference’ will be your adjustment. In most cases you’ll adjust the asset by the same amount, except in a few scenarios. More on that below.
To see how this practically works, please download our Excel example below, that guides you through the calculation and the required journals.
The Rubli IFRS 16 lease accounting tool has a step-by-step guide that helps you make the correct adjustment to your leases.
Remeasurements
In the initial lease measurement calculation, you’ll recall that you made a number of estimates (like the lease term) when calculating the lease liability. Since leases are multi-year contracts it is expected that these estimates will have to be reviewed and revised periodically. When these estimates are updated, you need to remeasure the lease liability using the new information.
Another common scenario that requires you to remeasure the liability is when there is a cash flow change on your lease payments. This can be because the inflation (CPI) increases that became effective or other rate changes (like interest rates) impacting your lease payments. Just as in the initial measurement, for the purpose of the calculation you’ll pretend this new payment stays constant until the end of the lease, even though you know it will change again in a year’s time. When it does, you simply remeasure it again and the cycle repeats.
For this reason, leases linked to CPI, or any other index is a lot more work to manage than any other type of lease.
For each type of remeasurement change, the standard is very specific on the discount rate that should be used.
You would use an updated (current) discount rate if:
- Your assessment of the lease term changes (either increased or decreased)
- Change in assessment of purchase options
- Lease payments changed due to floating interst rates
You would use the original discount rate if:
- Change in your estimate of the residual value guarantee
- Lease payment changes linked to an index
As explained above, you recalculate the lease liability with the new expected payments and appropriate discount rate. The ‘Lease difference’ adjustment will be accounted for against the lease liability and the asset (no P&L impact). In some instances, it might be a decrease that is larger than the asset’s carrying value. In this case the remaining adjustment amount will go to Profit and Loss.
Modifications
Any changes to a contract will result in a lease modification and depending on the type of change, IFRS 16 requires you to either remeasure the liability or create a new lease. There are essentially three types of modifications that we’ll look at below:
| Type of Modification | Example | Action |
|---|---|---|
| Increase in scope (and the increase in payments in is line with the increase in the asset) | Additional floor space added, and the lease payment increase by the same ratio | Create a new lease (no P&L impact) |
| Decrease in scope | The floor space or lease term is reduced | Remeasure the lease liability and adjust the asset (P&L impact) |
| Other contract changes | If the modification does not fall in the above two types. | Remeasure the lease liability (no P&L impact) |
Unlike remeasurements, for all types of modifications you’ll always use the current discount rate.
1. Increase in scope
In the case of an increase in scope (you are using more of the asset or over a longer period), you first need to determine if the increase in lease payments is in proportion with the stand-alone price for the increase in scope and any appropriate adjustments. If not, it falls under “Other contractual changes” – see below. If it is, then you need to create a new lease with the incremental amount.
Effectively the result of this is that the original lease would not be changed, and the new portion of this lease is a “new lease”.
It can be hard to separate the “new” payments from the original payments as the updated contract will probably only show the updated payments. You will have to subtract the original payments amount and only load the incremental payments as the new lease.
2. Decrease in scope
With a decrease in scope there are three steps to take:
- Adjust the asset with the same proportion as the decrease in scope (usually a percentage of the value).
- Remeasure the lease liability.
- Calculate if there is a Profit and Loss impact.
When you have a decrease in scope (using less of the asset or over a shorter period), a disposal of your asset will have to be recognized in proportion to the change in scope. This can be a reduction in floor space or a component that is removed from your vehicle.
Then you perform your calculation for the ‘lease difference’ adjustment and adjust the lease liability accordingly.
This type of change will result in a Profit and Loss impact, and this is calculated as the remaining difference after the asset and liability adjustment.
3. Other contract changes
If your modification doesn’t fit into one of the categories above, then it is considered ‘other contract’ changes. In this scenario, you simply remeasure the liability, by following the exact same calculation method as with a remeasurement using an updated rate as explained above.
Download the Excel workbook below to see a practical example of a lease modification.
Closing
As you can see there is a few steps to take before you know in which lease change category you fall.
This brings us to the end of the fundamental lessee account treatment and the only thing remaining for IFRS 16, is the reporting and disclosure requirements.
In our next guide we will look at the IFRS 16 requirements for presentation and disclosure and how to deal practically with some of these challenges.
If you have a lease portfolio that consists of a large number of leases, or leases that have ever-changing requirements, then please get in touch to discuss how we can assist.
