IFRS 16 Modification short-term lease

IFRS 16 Modification short-term lease – The life of a short-term lease

The lease term

It all starts with determining the lease term on the commencement date of the lease. A short-term lease must have a lease term of 12 months or less determined on the commencement date. Furthermore, it must not contain any purchase options – if it does, it automatically fails the short-term lease definition.

The lease term comprises the non-cancellable period of a lease together with periods covered by an option to extend (terminate) the lease if the lessee is reasonably certain (not) to exercise that option. The relationship between the non-cancellable period, lease term, and enforceable period of a lease can be illustrated as follows:

Enforceable period

No contract

Lease term

Non-cancellable period

Initial period

Option to extend1

Ability to continue the lease is not enforceable (IFRS 16 BC127)2

Lessee has no option to terminate

(see below)

Lessee is reasonably certain to exercise the option

Lessee is not reasonably certain to exercise the option

The determination of the lease term upon a lease extension (i.e. renewing the lease of the existing asset without leasing any additional assets) depends on whether the original lease is a short-term lease:

  • If the original lease is a short-term lease, a lessee applies IFRS 16 7 to the modification. IFRS 16 7 requires any modification of a short-term lease to be considered a new lease on the effective date of the modification. This means that an entity will have to assess the lease term of the new lease to determine if it continues to qualify for the short-term lease exemption.
  • If the original lease is not a short-term lease, a lessee applies IFRS 16 44-46 to the modification. In the context of an extension of the lease term, since it does not add the right to use one or more underlying asset, the lease is accounted for as a continuation of the original lease and so the lease term is determined from the commencement date of the original lease to the end of the extended period.

IN SUMMARY FROM ABOVE

Original lease term

Extension accounted for as….

Revised lease term

Short-term

A new lease on the effective date of the modification

Determine from effective date of modification to end of extended period

Not short-term

A continuation of the original lease

Determine from commencement date of original lease to end of extended period

Examples of short-term lease modifications

Note: All cases have a calendar year of reporting

CASE – Modification qualifies for the short-term lease recognition exemption

Lessee has a short-term lease that runs from 1 January 2019 to 31 December 2019. There are no extension options. Lessee and Lessor agree on 1 October 2019 to extend the lease for six months from 1 January 2020 to 30 June 2020.

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Lessee elects to apply the short-term lease recognition exemption in accordance with IFRS 16 5 to all short-term leases.

IFRS 16 Modification short-term lease

Consider this!

Since the original lease is a short-term lease to which Lessee has elected to apply the short-term lease exemption, IFRS 16 6-8 apply. In accordance with IFRS 16 7(a), the lease is considered a new lease if there is a lease modification. There is a modification on 1 October 2019 because the lease has been extended and this extension was not contemplated in the original terms of the lease.

Consequently, the new lease has a commencement date of 1 October 2019 and a lease term of nine months, thus it meets the definition of a short-term lease and qualifies for the short-term lease exemption from 1 October 2019.

The consideration for the modified lease (i.e. existing rentals for October to December 2019 plus new rentals for January to June 2020) will be straight-lined (unless another basis is more appropriate) over the term of the new lease from 1 October 2019 to 30 June 2020.

Conclusion – The lease meets the definition of a short-term lease and remains off-balance sheet for the entire period under review.

CASE – Modification does NOT qualify for the short-term lease recognition exemption

Lessee has a short-term property lease that runs from 1 January 2019 to 31 December 2019. There are no extension options. Lessee and Lessor agree on 1 October 2019 to enter into a new lease to rent the same premises for 12 months from 1 January 2020 to 31 December 2020.

Lessee elects to apply the short-term lease recognition exemption in accordance with IFRS 16 5 to all short-term leases.

Modification no short term lease

Consider this!

Since the original lease is a short-term lease to which Lessee has elected to apply the short-term lease exemption, IFRS 16 6-8 apply. In accordance with IFRS 16 7(a), the lease is considered a new lease if there is a lease modification. As discussed in the Lease modifications – extending the lease term, entering into a new lease on the same underlying asset is tantamount to extending the lease term of the existing lease, which is a modification as defined.

Consequently, the new lease for the purposes of IFRS 16 7(a) has a commencement date of 1 October 2019 and a lease term of 15 months, thus it does not meet the definition of a short-term lease. As such, Lessee should recognise a right-of-use asset and lease liability for the new 15-month lease on 1 October 2019. The right-of-use asset and lease liability will appear in the 2019 annual financial statements.

Conclusion – The lease is a short-term lease and stays off-balance sheet from 1 January 2019 to 30 September 2019; it fails the short-term lease definition from 1 October 2019 and is recognised on-balance sheet from that date.

KEEP IN MIND – This last case is a very common example of rolling 12-month leases. The continued 12-month extensions every year before expiry of the original lease would cause the contract to fail the short-term lease definition. The lease will have to be brought on balance sheet upon the first extension as seen in this last example.

CASE – Modification of a lease that existed on the date of initial application

On 1 January 2019, the date of initial application of IFRS 16, Lessee has a lease of a residential unit that ends on 30 April 2019 with no extension or termination options. Prior to expiry of the lease, Lessee enters into negotiation with Lessor to extend the lease.

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Negotiations on the terms of the new lease are ongoing at 30 April 2019 and both parties agree to continue leasing the same unit on the same terms as the original lease until an agreement could be reached. They agree to provide the other party with one month’s notice to terminate the arrangement without penalty if either party wants to end the arrangement.

On 14 July 2019, Lessee and Lessor sign an agreement to lease the same unit for another 12 months starting from 1 August 2019 to 31 July 2020 at a revised rent. There are no renewal or termination options under the new agreement. They also agree that Lessee can occupy the same unit for the remainder of July 2019 at the original rent.

Lessee elects to apply the short-term lease recognition exemption in accordance with IFRS 16 5 to all short-term leases. It also elects to apply the transition practical expedient in IFRS 16 C10(c) to account for all leases with a lease term of less than 12 months at the date of initial application as short-term leases.

Example modification existed

Consider this!

Since the lease has a remaining lease term of four months at the date of initial application, it qualifies for the transition practical expedient in IFRS 16 C10(c) to be accounted for as a short-term lease. As such, IFRS 16 6-7 apply and the lease is off-balance sheet from the date of initial application to 30 April 2019.

For the period between 1 May 2019 and 13 July 2019, the lease is a month-to-month lease because both Lessee and Lessor could terminate the lease unilaterally with no penalty by serving only one month’s notice to the other party (IFRS 16 B34). Each extra day stayed during this period is effectively a modification of the existing lease to extend it for one more day. In terms of IFRS 16 7(a), the lease is accounted for as a ‘new’ one-month lease every day during this period.

Similarly, when Lessee and Lessor agree on 14 July 2019 to extend the lease to 31 July 2020, the original one-month lease is modified and is accounted for as a new lease in terms of IFRS 16 7(a). The ‘new’ lease has a commencement date of 14 July 2019 and a lease term of 12 months and 18 days, therefore it is not a short-term lease as defined from 14 July 2019.

As such, Lessee should recognise a right-of-use asset and lease liability for the new 12-month 18-day lease on 14 July 2019. The right-of-use asset and lease liability will appear in the 2019 annual financial statements.

Conclusion: the lease is a short-term lease and stays off-balance sheet from the date of initial application to 13 July 2019; it is recognised on-balance sheet from 14 July 2019.

Example of lease modifications not being a short-term lease

CASE – Original lease is NOT a short-term lease

Lessee has a lease of a machine for two years that runs from 1 January 2019 to 31 December 2020. There are no extension options. Lessee and Lessor agree on 1 October 2020 to extend the lease for six months from 1 January 2021 to 30 June 2021.

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Modification no short term lease no

Consider this!

The agreement to extend the lease is a modification because it was not contemplated in the original terms of the lease. Since the modification does not add the right to use one or more underlying assets, it does not meet the criteria in IFRS 16 44(a) to be accounted for as a separate lease. The commencement date of the modified lease remains 1 January 2019, i.e. the date when the machine was first made available for use by Lessee.

Accordingly, the total lease term of the modified lease is 2.5 years. It would be incorrect to treat the lease as a short-term lease from 1 October 2020, being the effective date of the modification, on grounds that the remaining term of the lease is nine months from that date.

Lessee should remeasure the lease liability on 1 October 2020 to reflect the present value of the modified lease payments from 1 October 2020 to 30 June 2021 discounted using a revised discount rate on that date (IFRS 16 45). A corresponding adjustment is made to the right-of-use asset (IFRS 16 46(b)).

Conclusion: At no point in time is this lease a short-term lease.

Impact of termination options

(Reference from lease term table – Lessee has no option to terminate)

Lease contracts often contain termination options. The determination of the lease term is affected by which party has the right to exercise the termination option.

  • Lessor-only termination options – these are ignored when determining the lease term because the lessee has an unconditional obligation to pay for the full period of the lease, unless and until the lessor decides to terminate the lease(IFRS 16 B35 and BC128).

  • Lessee-only termination options – the lease term is determined by assessing whether the lessee is reasonably certain to exercise the termination option(IFRS 16 18(b)).

  • Both parties have the option to terminate the lease – this affects the enforceable period of the lease. If both the lessee and the lessor can terminate the lease unilaterally on a particular date(s) with no more than an insignificant penalty, the lease is no longer enforceable beyond that date (IFRS 16 B34).

IFRS 16 Modification short-term lease

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