How inflation-indexed lease payments are accounted for under IFRS 16 and ASC 842

Many real estate and infrastructure leases link periodic payments to inflation indices (e.g., CPI, HICP, RPI) or to market rates. Under IFRS 16 and US GAAP (ASC 842), these payments are treated differently from purely fixed payments: they are included in the lease liability using the index or rate at commencement, and then the lease is remeasured when cash flows change because the referenced index/rate resets. Getting this right affects right-of-use (ROU) assets, liabilities, EBITDA, and debt ratios.

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How index-linked lease mechanics flow into initial measurement.

At commencement, both frameworks include in the lease liability:

• Fixed payments (including in-substance fixed).

• Variable payments that depend on an index or a rate, measured using the index/rate at commencement (i.e., assume today’s index; do not forecast future inflation at day one).

• Residual value guarantees expected to be payable.

• Exercise price of purchase options that are reasonably certain to be exercised.

• Termination penalties if the term reflects exercising the termination option.

Discount using the incremental borrowing rate (or the implicit rate if readily determinable). The ROU asset generally equals the lease liability adjusted for prepayments, initial direct costs, and incentives.

Illustration (day one):

• Base rent €100,000 annually, indexed to CPI (current CPI factor = 1.00).

• Discount rate (IBR) 6%, non-cancelable term 5 years.

At commencement, model payments as €100,000 each year (no forward inflation). Record:

• Dr ROU Asset (balancing figure) xx

• Cr Lease Liability (PV of five €100,000 payments @ 6%) €421,236

• Adjust for prepayments/IDC/incentives as applicable.

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When and how remeasurement happens as CPI (or rates) move.

IFRS 16

• Trigger: When cash flows change because the index/rate has reset (e.g., the landlord issues a notice that next year’s rent is €100,000 × 1.06 due to CPI +6%).

• What to remeasure: Recalculate the remaining lease liability using the revised payments from the date the change takes effect over the remaining term.

• Discount rate:

  • Use the original discount rate for index-based changes (e.g., CPI).

  • Use a revised discount rate if payments vary with a floating interest rate (e.g., IBOR-linked rent).

• ROU asset: Adjust the ROU asset by the same amount as the lease liability remeasurement (unless the asset is fully impaired).

ASC 842 (lessee)

• Trigger: Similar—remeasure when future consideration changes due to a change in the index or rate used to determine the lease payments.

• What to remeasure: Update the lease liability for the remaining payments based on the new index/rate; adjust the ROU asset correspondingly.

• Discount rate: Common practice mirrors IFRS: for index resets like CPI, retain the original discount rate; for reference-rate changes (e.g., SOFR/IBOR-indexed rent), a revised discount rate is used in remeasurement.

• No remeasurement is made for mere changes in expected future index levels before they actually affect contractual cash flows.

Note: Remeasurement for other events (e.g., lease term changes, assessment of options, residual guarantees, modifications) follows the frameworks’ general remeasurement rules, which can also require updating the discount rate.

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Worked example — CPI step-up after commencement (lessee).

Facts (continuing):

• End of Year 1, CPI increases 6%. New annual rent from Year 2 onward = €106,000.

• Remaining term: 4 years.

• IFRS 16 and ASC 842 treatment (index change):

  1. Compute the present value of four €106,000 payments using the original 6% rate.

     PV(4×€106,000 @6%) = €374,222.

  2. Determine the carrying amount of the lease liability immediately before remeasurement (after Year-1 accretion and cash payment). Suppose it is €354,312.

  3. Increase the lease liability by €19,910 (€374,222 − €354,312).

  4. Entry:

     • Dr ROU Asset €19,910

     • Cr Lease Liability €19,910

  Depreciate the updated ROU asset prospectively over the remaining 4-year term.

Income statement effect: No immediate P&L hit on remeasurement (unless the ROU asset is impaired); future depreciation and interest rise because both asset and liability increased.

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What is included vs excluded from day-one measurement.

Included at commencement (using then-current index/rate):

• CPI/HICP/RPI-linked base rent.

• Rate-indexed rent (e.g., SOFR-linked) using current rate.

• In-substance fixed minimums (e.g., floor that always applies).

Excluded at commencement:

• Usage-based payments (e.g., % of sales, per-unit output).

• True variable payments not tied to an index/rate (market performance metrics).

These excluded amounts hit P&L as incurred (variable lease expense) and are not part of the lease liability.

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Comparative framework — IFRS 16 vs ASC 842 (lessee focus).

Topic	IFRS 16	ASC 842
Variable tied to index/rate at day one	Include using index/rate at commencement	Include using index/rate at commencement
Forecast future index/rate	Do not forecast	Do not forecast
Remeasure for index/rate changes	Yes, when payments change	Yes, when payments change
Discount rate on remeasurement	Keep original for CPI; update for floating rates	Practice generally mirrors IFRS (retain for CPI; update for floating-rate resets)
ROU asset on remeasurement	Adjust ROU asset	Adjust ROU asset
Usage-based variable payments	Expense as incurred	Expense as incurred
Lessee EBITDA impact	Variable index amounts become part of depreciation/interest after remeasurement	Same pattern; EBITDA improves vs straight variable expensing

Note: ASC 842 and IFRS 16 both have detailed rules for lease modifications (e.g., adding space, changing term); those can require reassessment of classification and discount rate separate from index/rate resets.

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Journal entries summary (lessee).

At commencement (indexed lease):

• Dr ROU Asset xx

• Cr Lease Liability xx

Each period (before any index reset):

• Dr Interest Expense xx

• Cr Lease Liability xx

• Dr Depreciation Expense – ROU xx

• Cr Accumulated Depreciation – ROU xx

• Dr Lease Liability xx

• Cr Cash xx

At CPI reset date (payments increase):

• Dr ROU Asset (remeasurement uplift) xx

• Cr Lease Liability xx

Usage-based variable rent (excluded items):

• Dr Variable Lease Expense xx

• Cr Cash/Payables xx

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Lessor considerations in index-linked leases (high level).

• IFRS 16 & ASC 842 lessor accounting does not recognize a lease receivable for index changes until they affect billings; finance lessors reflect the variability through income recognition as contingent rentals.

• For operating leases, variable amounts tied to index/rate are generally recognized in income as earned when the index affects cash flows.

• Lessors should disclose variable lease payments and indexation terms prominently, as they influence credit risk and timing of income.

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Disclosure package that analysts expect.

• Description of index/rate mechanisms (cap/floor, lags, reset dates).

• Maturity analysis of undiscounted cash flows, highlighting sensitivity to index movements.

• ROU asset roll-forward and lease liability reconciliation, including remeasurement effects.

• For material portfolios, sensitivity (e.g., effect of a 1-point CPI shift on next-year lease expense and liability).

Clear disclosures allow readers to distinguish contractual leverage (lease debt) from pure variable exposure (usage-based rent).

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