How lease modifications are accounted for under IFRS 16 and ASC 842

Lease contracts often change after commencement—space is added or reduced, terms are extended or shortened, or consideration is renegotiated. IFRS 16 and US GAAP (ASC 842) both define a lease modification as a change in scope or consideration not part of the original terms. The accounting hinges on whether the modification creates a separate lease and, if not, how to remeasure the existing right-of-use (ROU) asset and lease liability.

·····

.....

When a modification is a separate lease

A modification is a separate lease if both conditions are met:

• The scope increases by adding the right to use one or more underlying assets, and

• The consideration increases by an amount commensurate with the standalone price for the increase (adjusted for contract specifics).

Result: account for the new portion as a new lease; the original lease remains unchanged.

Example: A tenant adds an extra floor for a price broadly aligned with market rent for that floor. Record a new lease for the added floor.

·····

.....

How to account for modifications that are not separate leases (lessee)

If the modification is not a separate lease, remeasure the existing lease on the effective date of the modification.

Classification reassessment (IFRS 16 & ASC 842):

• IFRS 16: reassess lease classification only if the modification changes the scope or consideration.

• ASC 842: similar; reclassify if the modification would have resulted in a different classification at commencement.

Discount rate: use a revised discount rate at the modification date (current IBR or implicit rate if determinable).

Scope change outcomes (lessee):

• Decrease in scope (e.g., reduce area or lease term):

  • Decrease the lease liability, and decrease the ROU asset proportionately; recognize any difference in P&L.

• Increase in scope without separate lease (e.g., extend term, add space at a non-commensurate price):

  • Increase the lease liability for revised cash flows discounted at the new rate; adjust the ROU asset by the same amount.

Illustrative entries (lessee):

• Decrease scope:

  • Dr Lease Liability xx

  • Cr ROU Asset (proportional) xx

  • Cr / Dr Gain or Loss (plug) xx

• Increase scope / consideration:

  • Dr ROU Asset xx

  • Cr Lease Liability xx

·····

.....

Worked example A — partial termination (lessee)

Facts:

• Original lease: 5 years, annual payments €100,000, IBR 6%, operating office space.

• After 2 years, tenant surrenders 20% of the space; remaining term: 3 years.

• New annual payments = €80,000; new IBR at modification = 7%.

Steps:

1. Measure the lease liability for revised payments (€80,000 for 3 years at 7%). Suppose PV = €205,694.

2. Determine carrying amounts just before modification: liability €257,000; ROU asset €240,000.

3. Record scope decrease (20%): reduce ROU asset by 20% of its carrying amount (€48,000).

4. Update liability to PV of revised payments: reduce liability from €257,000 to €205,694 → decrease €51,306.

5. Recognize difference to P&L:Decrease in liability (€51,306) − decrease in ROU (€48,000) = €3,306 gain.

Entry:

• Dr Lease Liability 51,306

• Cr ROU Asset 48,000

• Cr Gain on Lease Modification 3,306

Subsequent depreciation uses the reduced ROU asset over the remaining 3 years.

·····

.....

Worked example B — term extension at below-market rate (lessee)

Facts:

• Original lease: 4 years, €120,000 per year, IBR 5%, 2 years remaining.

• Parties extend term by 3 more years at €110,000 annually; new IBR = 6%.

Accounting (not a separate lease — price not commensurate):

1. Recalculate lease liability using revised cash flows (2 years at €120,000 + 3 years at €110,000) discounted at 6%.

2. Increase the lease liability by the difference versus carrying amount.

3. Adjust ROU asset by the same amount (no immediate P&L).

Entry (illustrative):

• Dr ROU Asset xx

• Cr Lease Liability xx

Depreciate the revised ROU asset over the remaining 5-year modified term.

·····

.....

Lessor accounting for modifications

Operating lease (lessor):

• Treat as a new lease from the effective date if the modification is substantive; recognize rental income prospectively.

Finance lease (lessor):

• If the modification would have resulted in operating classification at inception, account as a termination of the original and a new lease (remeasure net investment; recognize gain/loss).

• Otherwise, adjust the net investment in the lease using a revised discount rate and updated cash flows; recognize gain/loss for scope reductions.

Sublease chains:

• For an intermediate lessor (lessee-sublessor), a modification of the head lease may require reassessment of the sublease classification and remeasurement to keep the sublease aligned with the head lease.

·····

.....

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

Topic	IFRS 16	ASC 842
Separate lease test	Scope and commensurate price	Same
Discount rate on modification	Revised rate at modification	Revised rate at modification
Decrease in scope	Reduce ROU proportionally; diff → P&L	Same
Increase in scope (not separate)	Adjust liability/ROU; no immediate P&L	Same
Reclassify lease type	Reassess if modification changes classification	Similar reassessment
Lessor treatment	New lease or adjust net investment depending on facts	Similar concepts with GAAP-specific detail

·····

.....

Journal entries summary (lessee)

Separate lease created:

• Dr ROU Asset (new) xx

• Cr Lease Liability (new) xx

Not separate — scope decrease:

• Dr Lease Liability xx

• Cr ROU Asset (proportion) xx

• Cr / Dr Modification Gain or Loss xx

Not separate — scope increase / term extension:

• Dr ROU Asset xx

• Cr Lease Liability xx

Subsequent:

• Dr Interest Expense xx / Cr Lease Liability xx

• Dr Depreciation Expense xx / Cr Accumulated Depreciation – ROU xx

·····

.....

Disclosure package that avoids surprises

• Nature of modifications, effective dates, and rationale.

• Quantitative impact on lease liabilities and ROU assets, including gains/losses from scope reductions.

• Weighted-average remaining lease term and discount rate after modification.

• Maturity analysis revised for updated cash flows.

• For lessors, changes in lease income recognition patterns and any reclassification between operating and finance leases.

·····

.....

Impact on financial performance and ratios

• EBITDA: Scope decreases may create one-time gains; ongoing EBITDA changes with new depreciation and interest patterns.

• Leverage & coverage: Modified liability and interest accretion alter leverage and interest coverage metrics.

• Liquidity: Revised payment schedules affect short-term vs long-term portions of lease liabilities.

• Comparability: Extensions or partial terminations change base depreciation; analysts should recast comparatives where material.

·····

.....

Operational considerations

• Build a modification checklist (scope, price commensurateness, discount rate, classification).

• Capture effective dates precisely—remeasure on that date only.

• Keep audit trails for proportional ROU reductions and P&L effects.

• Synchronize head lease and sublease modifications to avoid classification mismatches.

• Update covenant calculations and budget models for altered cash flows.

Properly identifying separate leases and applying the correct remeasurement mechanics ensures modifications are reflected transparently, aligning economic reality with reported assets, liabilities, and expenses.

·····

.....

FOLLOW US FOR MORE

DATA STUDIOS

.....

[datastudios.org]