IFRS 16: Lease Term

Lease term includes the following (IFRS 16.18):

  • non-cancellable period of a lease
  • periods covered by an option to extend the lease – if the lessee (customer) is reasonably certain to exercise that option; and
  • periods covered by an option to terminate the lease – if the lessee (customer) is reasonably certain not to exercise that option.

The lease term should not go beyond the ‘enforceable period’ which lasts up to a point when both parties have the right to terminate the lease without permission from the other party with no more than an insignificant penalty (IFRS 16.B34).

The lease term includes also any ‘rent-free’ periods (IFRS 16.B36).

The term ‘reasonably certain’ is not defined in IFRS, but it is considered to be a high probability, although lower than ‘virtually certain’.

Non-cancellable lease term is the period during which none of the parties have right to terminate the lease or only the lessor (supplier) has such a right (IFRS 16.B34-B35). If only the lessor has a right to terminate the lease, the lessee has an unconditional obligation to pay for the right to use the asset for the period and therefore such a period must be included in the lease term (IFRS 16.BC128).

A lease contract may give the lessee (customer) an option to extend or terminate the lease. If such an option exists, a lessee should assess whether it is reasonably certain to exercise that option. If so, exercising that option should be taken into account when determining a lease term. Paragraphs IFRS 16.B37-B40 provide examples of facts and circumstances that should be taken into account when making such an assessment.

It is crucial that extension or termination options are enforceable, i.e. they can be exercised by a lessee without any consent by the lessor (supplier) (IFRS 16.BC127). Additionally, when considering the options in a lease contract, an entity must be aware of the laws and regulations governing such agreements. It may be the case that the law imposes certain requirements on the lease term or possibility of early termination that cannot be overridden by provisions of a contract.

Example: Lease term #1

A lease contract starts on 1 January 20X1 and has the following features:

  • neither party to the contract can terminate the lease during the first 2 years
  • a customer (a lessee) can extend the contract for another 2 years and the supplier (a lessor) cannot refuse such an extension
  • if the customer exercises the option for another 2 years, neither party can terminate the lease during another 2 years
  • if the customer does not exercise the option for additional 2 years, the lease is still in force, but each party can terminate the lease with a 3-month notice period (when the notice is given after 1 year and 9 months, the lease term ends exactly after 2 years)

In this example, the lease term is 2 years or 4 years, depending on whether the lessee is reasonably certain to exercise the option to extend the lease:

Assessment of lease term under IFRS 16 (example 1)


Example: Lease term #2

A lease contract starts on 1 January 20X1 and has the following features:

  • neither party to the contract can terminate the lease during the first 2 years
  • the supplier (a lessor) can extend the lease for another 2 years after these 2 years, the customer (lessee) cannot withdraw from the additional 2 years
  • after additional 2 years, each party can terminate the lease with a 3-month notice period

In this example, the lease term is 4 years, as the non-cancellable period includes also the period during which only the lessor has a right to terminate the lease (IFRS 16.B34-B35):

Assessment of lease term under IFRS 16 (example 2)

A customer (a lessee) reassesses whether it is reasonably certain to exercise an extension option, or not to exercise a termination option, on the occurrence of either a significant event or a significant change in circumstances that (IFRS 16.20):

(a) is within the control of the lessee; and

(b) affects whether the lessee is reasonably certain to exercise an option not previously included in its determination of the lease term, or not to exercise an option previously included in its determination of the lease term.

Examples of significant events or changes in circumstances are given in paragraph IFRS 16.B41. As a result, lessees are not required to reassess the options at each reporting date or in response to purely market-based events or other changes in circumstances not within the control of the lessee (IFRS 16.BC184-BC187).

When there is a change in non-cancellable period, the lease term should be revised. Paragraph IFRS 16.21 gives examples of reasons for a change in non-cancellable period.

The right-of-use asset and a related liability is recognised at the commencement date, which is the date on which a lessor (a supplier) makes an underlying asset available for use by a lessee (IFRS 16.Appendix A).

The contract is not recognised at the inception date if the underlying asset is not yet available for use by a lessee (IFRS 16.BC141-BC144). Inception date is defined as the earlier of the date of a lease agreement and the date of commitment by the parties to the principal terms and conditions of the lease (IFRS 16.Appendix A).

See other pages relating to IFRS 16:

IFRS 16 Leases: Scope of IFRS 16

IFRS 16 Leases: Identifying a Lease

IFRS 16 Leases: Recognition and Measurement of Leases

IFRS 16 Leases: Lessor accounting

IFRS 16 Leases: Transition from IAS 17 to IFRS 16

 


© 2018-2019 Marek Muc

Excerpts from IFRS Standards come from the Official Journal of the European Union (© European Union, https://eur-lex.europa.eu). The information provided on this website does not constitute professional advice and should not be used as a substitute for consultation with a certified accountant.