A lessee currently leases two floors of an office building. Partway through the lease term, the lessee and lessor agree to a modification that removes the lessee's right to use one of the two floors, with a proportionate reduction in future lease payments, while leaving all other terms unchanged. Under IFRS 16 paragraphs 44-46, how should the lessee account for this modification?
- Because the modification changes the consideration and reduces the lessee's rights, the lessee accounts for it as a separate new lease for the remaining floor while continuing to recognize the original right-of-use asset and lease liability for the floor no longer used
- The lessee makes no adjustment to the right-of-use asset and instead recognizes the entire reduction in future payments directly in profit or loss as a one-time gain, since the underlying lease liability is not affected by a decrease in scope
- Because the modification decreases the scope of the lease rather than adding a new underlying asset, the lessee remeasures the lease liability using a revised discount rate, decreases the carrying amount of the right-of-use asset to reflect the partial termination, and recognizes any resulting gain or loss in profit or loss
- The lessee treats the modification as a change in an index or rate affecting future lease payments and remeasures only the lease liability, using the original discount rate, without any adjustment to the right-of-use asset
Why C? And why not the others?
Correct answer: C. Because the modification decreases the scope of the lease rather than adding a new underlying asset, the lessee remeasures the lease liability using a revised discount rate, decreases the carrying amount of the right-of-use asset to reflect the partial termination, and recognizes any resulting gain or loss in profit or loss
IFRS 16 paragraph 44 requires a lease modification to be treated as a separate lease only when it increases the scope of the lease by adding a right to use additional underlying assets at a commensurate standalone price; because this modification removes the right to use one floor rather than adding anything, it is not a separate lease, and paragraph 46 instead requires the lessee to remeasure the lease liability with a revised discount rate, decrease the right-of-use asset to reflect the partial termination, and recognize any resulting gain or loss in profit or loss. The option treating a scope reduction as giving rise to a new separate lease is wrong because paragraph 44's separate-lease treatment applies only to scope increases, not decreases. The option recognizing the full payment reduction as a profit-or-loss gain without adjusting the right-of-use asset is wrong because paragraph 46 specifically requires the carrying amount of the right-of-use asset to be decreased in proportion to the partial termination before any gain or loss is recognized. The option using the original discount rate and treating this as an index-driven remeasurement is wrong because a lease modification requires a revised discount rate determined at the effective date of the modification, unlike routine remeasurements triggered solely by changes in an index or rate.
Source: IFRS 16 Leases, paragraphs 44-46 (lease modifications)