What is meant by 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 its original terms and conditions. Examples of lease modifications are as follows:
- increasing the scope of the lease by adding the right to use additional underlying assets
- decreasing the scope of the lease by removing the right to use of some underlying assets
- increasing the scope of the lease by extending the contractual lease term
- changing the consideration in the lease by increasing or decreasing the lease payments
Changes that result from renegotiations and changes to the terms of the original contract are lease modifications.
A lessee should account for a lease modification as a separate lease if both:
- the modification increases the scope of the lease by adding the right to use additional 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.
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 a lessee should:
- allocate the consideration in the modified contract
- determine the lease term of the modified lease
- remeasure the lease liability by discounting the revised lease payments using a revised discount rate. The revised discount rate is determined as the interest rate implicit in the lease for the remainder of the lease term, if that rate can be readily determined, or the lessee’s incremental borrowing rate at the effective date of the modification, if the interest rate implicit in the lease cannot be readily determined.
Remeasurement of lease liability
- For a lease modification that is not accounted for as a separate lease, the lessee should account for the remeasurement of the lease liability by:
- decreasing the carrying amount of the right-of-use asset to reflect the partial or full termination of the lease for lease modifications that decrease the scope of the lease. The lessee should recognise in profit or loss any gain or loss relating to the partial or full termination of the lease.
- making a corresponding adjustment to the right-of-use asset for all other lease modifications.
Modifications are different from reassessments
There is a difference between scenarios that result in the remeasurement of existing lease assets and lease liabilities due to:
- reassessment of estimates used in lease accounting; and
- lease modifications
After the commencement date, lease reassessments take place, for example, when there are changes in the cash flows of lease payments based on contractual clauses included in the original contract.
Examples that result in reassessments for lessees include changes in the following:
- assessment of the lease term
- assessment of whether a purchase option will be exercised
- expected amount payable under a residual value guarantee
- future lease payments from a change in the index or rates used to determine those payments
- lease payments resulting from a change in floating interest rates; or
- variable lease payments becoming fixed or in-substance fixed payments.
After the commencement date, a lessee should remeasure the lease liability to reflect changes to the lease payments. The lessee should adjust the carrying amount of the right-of-use asset for the remeasurement of the lease liability. If the carrying amount of the right-of-use asset has already been reduced to zero and there is a further reduction in the measurement of the lease liability, then the lessee should recognise any remaining amount of the remeasurement in profit or loss.