A lessee's original assessment of a ten-year lease with a five-year extension option concluded it was not reasonably certain to exercise the extension, so the lease term used to measure the lease liability was ten years. Three years into the lease, the lessee opens a large new production line in the leased building at significant cost, making it economically compelling to keep using the space well beyond the original ten years. Under IFRS 16 paragraphs 20-21, what should the lessee do?
- Take no action, because IFRS 16 only permits reassessment of the lease term at the original commencement date, never afterward
- Reassess the lease term only at the next annual reporting date that coincides with the lease's original inception anniversary, since IFRS 16 mandates reassessment strictly on a fixed annual cycle rather than upon a triggering event
- Reassess whether it is now reasonably certain to exercise the extension option, because the new production line is a significant event within the lessee's control that affects whether exercising the option is reasonably certain, and revise the lease term and remeasure the lease liability if the conclusion changes
- Treat the new production line as a lease modification and account for the extension option as if the lessee and lessor had renegotiated a brand-new lease contract, even though the original contract's extension option and its terms are unchanged
Why C? And why not the others?
Correct answer: C. Reassess whether it is now reasonably certain to exercise the extension option, because the new production line is a significant event within the lessee's control that affects whether exercising the option is reasonably certain, and revise the lease term and remeasure the lease liability if the conclusion changes
IFRS 16 paragraphs 20-21 require a lessee to reassess whether it is reasonably certain to exercise an extension option when a significant event or significant change in circumstances occurs that is within the lessee's control and affects that assessment; investing heavily in a new production line that depends on continued occupancy of the space is exactly such an event, so the lessee must reassess and, if its conclusion changes, revise the lease term and remeasure the lease liability accordingly. The option barring any reassessment after commencement is wrong because paragraphs 20-21 exist specifically to require reassessment during the lease term when qualifying triggers occur, not only at inception. The option limiting reassessment to a fixed annual cycle tied to the lease's inception anniversary is wrong because IFRS 16 ties reassessment to the occurrence of a qualifying triggering event, not to a calendar schedule. The option treating the situation as a lease modification requiring a renegotiated contract is wrong because nothing about the original contract's extension option or its terms has changed; modification accounting applies to a change in the scope or consideration of a lease agreed between lessor and lessee, not to a lessee's internal reassessment of its own intentions under an unchanged contract.
Source: IFRS 16 Leases, paragraphs 20-21 (reassessment of lease term)