The International Financial Reporting Standards (IFRS), notably IFRS-16, altered how businesses account for leases in their financial accounts. Understanding and dealing with lease adjustments is a critical component of this standard. Let’s get started by making sense of lease adjustments in a way that’s both simple and useful.
What Exactly Is A Lease Modification?
A lease modification, according to IFRS-16, is any change in the scope of a lease, or the consideration (payment) for a lease, or both. Changes in the lease period, the quantity or value of leased items, or changes in rental payments are all examples of lease adjustments.
Consider the case of Company A, which rents office space in a building. If they decide to rent additional floors, they will need to modify their contract because the scope (amount of space rented) has expanded. Similarly, if a corporation renegotiates its contract in order to lower its monthly payments, that change in lease consideration is also considered a lease modification.
Lease Modification Accounting
The manner in which we account for lease adjustments is determined by the type of change. In general, there are two basic scenarios to consider:
Increase in Scope and Remuneration: When a lease amendment results in increased rights to use one or more underlying assets, the lease payments increase in proportion. Such modifications are recognized as distinct leases. The previous lease remains in effect, and a new lease is created to account for the increased rights and obligations.
Let us return to Company A, which opted to lease more floors. For these additional floors, they will record a new right-of-use asset and lease obligation, although the accounting for the old lease will stay unaltered.
Other Lease Modifications: These are any adjustments that do not result in a new lease. In such circumstances, the lease modification is handled as if the original lease had been replaced with a new lease on the effective date of the modification. This entails recalculating the lease liabilities with a new discount rate and adjusting the right-of-use asset accordingly.
If Company A renegotiated its existing lease to reduce future lease payments without changing the space leased, the lease obligation and accompanying right-of-use asset would be reduced to reflect the lower lease payments.
Measuring Lease Liability and Asset Right-of-Use
When a lease modification does not result in the creation of a new lease, the lessee remeasures the lease liability by discounting the amended lease payments using a new discount rate, which is effective from the modification date.
The asset of right-of-use is then adjusted by the same amount. If the remeasurement increases the lease liability, the right-of-use asset increases as well. In contrast, if the remeasurement reduces the lease liability, the right-of-use asset decreases. However, if this adjustment reduces the right-of-use asset to less than zero, the lessee recognizes any residual remeasurement amount in profit or loss.
Lease adjustments under IFRS-16 may appear difficult, but knowing the fundamentals will be quite beneficial. Lease modifications, which involve changes to the scope or consideration of a lease, can have a major impact on the balance sheet and even the income statement. Modifications that expand the scope and payments are handled as new leases, whilst all others require recalculating the lease debt and amending the right-of-use asset.
Remember that understanding the intricacies of lease modifications is a critical component of completely comprehending IFRS-16. When in doubt, always seek the advice of a financial counselor or a professional knowledgeable in IFRS standards. Good luck with your accounting!