IFRS 16 Effective date of a modification

IFRS 16 Effective date of a modification

The date on which to account for a lease modification is a key consideration – and may be earlier than you think.

Lease modifications are accounted for at the effective date of the lease modification. This is the date on which both parties agree to the lease modification. For modifications that are not accounted for as separate leases, the lease liability and right-of-use asset are remeasured at this date.

Complex application issues arise if the modification is agreed on one date but an additional right of use starts on a later date. This section illustrates some issues. IFRS 16 Effective date of a modification

The following diagram summarises the accounting for common scenarios in which a modification is agreed on one date but the change in the right of use or consideration happens at a different date. IFRS 16 Effective date of a modification

IFRS 16 Effective date of a modification

When a modification is accounted for as a separate new lease, it is accounted for in the same way as any other new lease.

A Worked example – IFRS 16 Effective date of a modification is before a termination of the right to use an underlying asset takes effect

Lessee Y enters into a lease for a five-year term with Lessor L for a retail building. Under the lease, Y obtains the right to use 10,000m2 of the retail space.

At the end of Year 3, Y and L sign a modified contract whereby Y will lease 7,000m2 of the original space for the last year of the lease – i.e. a decrease in scope by partially terminating the right of use.

The lease payments are reduced accordingly. That is, 3,000m2 of retail space will be returned to L at the end of Year 4 and Y will lease 7,000m2 for Year 5.

IFRS 16 Effective date of a modification

Effective date of modification

The modified contract is signed at the end of Year 3. This is the date when both Y and L agree to the lease modification; therefore, this is the effective date of the modification.

IFRS 16 Measurement of modification and IFRS 16 Recognition of modification

This is a lease modification that is not accounted for as a separate lease.

Y accounts for the reduction in scope by reducing the lease liability, reducing the right-of-use asset and recognising any related gain or loss (for the lessee accounting for modifications).

Y recognises and measures the decrease in scope at the end of Year 3 when the decrease in scope is contractually agreed, and not when it actually takes place at the end of Year 4.

This is because at the end of Year 3 both parties have contractually agreed on Y’s obligation to pay for the right of use for only 7,000m2 in Year 5, Y’s rights related to use of the underlying asset of 7,000m2 in Year 5 and the cost of Y’s right-of-use asset.

Even though Y still has 10,000m2 of the underlying asset under its control for Year 4, under lessee accounting Y recognises its right of use, not the underlying asset.

At the end of Year 3, Y adjusts the right-of-use asset to reflect the contractual agreement that Y has the right to use 10,000m2 in Year 4 but only 7,000m2 in Year 5.

This adjustment to the right-of-use asset will impact subsequent depreciation. In this case, depreciation in Year 4 will be calculated as (10,000 / 17,000) x the carrying amount of the right-of-use asset at the beginning of Year 4.

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As noted above, complex application issues arise when a modification that increases the scope by adding the right to use an additional underlying asset is not accounted for as a separate new lease, and the modification is agreed on one date but the additional right of use starts at a later date.

In this case, a lessee calculates the modified lease liability at the effective date of the lease modification.Balance

However, IFRS 16 is not clear on when the lessee should recognise the increase in the lease liability and the right-of-use asset related to the additional underlying asset.

An acceptable approach is to recognise the increase in the lease liability and the right of use when the lessee gets access to this additional underlying asset – i.e. when the lease of the additional underlying asset commences (reference IFRS 16.22, Ex18).

This is consistent with the general requirement to recognise the lease at the commencement date.

B Worked example – IFRS 16 Effective date of a modification is before an addition to the right to use an underlying asset takes effect

Lessee Y enters into a lease for a five-year term with Lessor L for part of a retail building. Under the lease, Y obtains the right to use 10,000m2 of the retail space.

At the end of Year 3, Y and L sign a modified contract whereby Y will lease 15,000m2 of retail space for the last year of the lease – i.e. an increase in scope by adding the right to use one or more underlying assets.

That is, Y leases an additional 5,000m2 of retail space effective from the end of Year 4. Assume that the modification is not accounted for as a separate lease because the price for the additional space is not commensurate with the stand-alone price.

an addition to the right to use an underlying asset takes

IFRS 16 Effective date of a modification

The modified contract is signed at the end of Year 3. This is the date when both Y and L agree to the lease modification; therefore, this is the effective date of the modification.

IFRS 16 Measurement of modification and IFRS 16 Recognition of modification

In this scenario, at the end of Year 3, the effective date of the modification, Y has entered into a new contract with two lease components – i.e. the original office space and the new office space.

The first component starts immediately but the second component is forward-starting.

Consequently, at the end of Year 3, Y determines the amounts that should be recognised in respect of each component.

This includes allocating the total consideration of the modified contract between the two components, determining the lease term and remeasuring the lease liability by discounting the revised lease payments at a revised discount rate.

The portion allocated to the original lease component is accounted for from the effective date of the modification.

It is acceptable to account for the portion allocated to the new lease component at the commencement date of the new office space at the end of Year 4 – i.e. when L makes available the additional right to use the 5,000m2 to Y.

At that time, Y recognises the lease liability and right-of-use asset with respect to the new office space based on amounts determined at the effective date of the modification – i.e. at the end of Year 3.

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C Worked example – IFRS 16 Effective date of a modification when there is an increase in lease term

Lessee Y enters into a lease for a five-year term with Lessor L for part of a retail building. Under the lease, Y obtains the right to use 10,000m2 of the retail space.

At the end of Year 3, Y and L sign a modified contract whereby Y will lease the 10,000m2 of original space for an additional five years. That is, the lease term is now 10 years in total.Scenario

Effective date of modification

The modified contract is signed at the end of Year 3. This is the date when both Y and L agree to the lease modification; therefore, this is the effective date of the modification.

IFRS 16 Measurement of modification and IFRS 16 Recognition of modification

This is a lease modification that is not accounted for as a separate lease.

Y already has the right to use the underlying asset; there has been no change in its rights except that it can now use the asset for a longer period. Y measures and recognises the change in lease term at the end of Year 3.

D Worked example – IFRS 16 Effective date of a modification: Forward-starting lease

Lessee Y enters into a five-year lease of earth-moving equipment with Lessor Z.

At the beginning of Year 3, Y and Z enter into a new agreement to lease the same earth-moving equipment for five years commencing immediately at the end of Year 5 (i.e. when the original five-year lease expires).

This new agreement is known as a ‘forward-starting lease’. The original agreement remains effective until the end of Year 5 without any changes, at which point the modified terms come into effect.

The forward-starting lease is a lease modification. This is because Y already has the right to use the underlying asset.

No additional right to use one or more underlying assets has been added. Therefore, Y remeasures the right-of-use asset and the lease liability at the beginning of Year 3, which is the effective date of the modification.

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See also: Grant Thorton – IFRS 16 Effective date of a modification

IFRS 16 Effective date of a modification

IFRS 16 Effective date of a modification IFRS 16 Effective date of a modification IFRS 16 Effective date of a modification

IFRS 16 Effective date of a modification IFRS 16 Effective date of a modification IFRS 16 Effective date of a modification

IFRS 16 Effective date of a modification IFRS 16 Effective date of a modification IFRS 16 Effective date of a modification

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Something else -   IAS 32 Clearly distinguishing liability and equity

IFRS 16 Effective date of a modification IFRS 16 Effective date of a modification IFRS 16 Effective date of a modification

IFRS 16 Effective date of a modification IFRS 16 Effective date of a modification IFRS 16 Effective date of a modification

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