What triggers a reassessment of the lease term under IFRS 16 and how does it affect the liability?

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AcadiFi · Accepted Answer

Under IFRS 16, a lessee must reassess the lease term when a significant event or change in circumstances occurs that is within the lessee's control and affects whether...

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**Key Triggers for Reassessment:**

1. **Significant leasehold improvements** -- Investing heavily in the leased space makes extension more likely
2. **Material changes in business strategy** -- Closing a division that uses the leased asset
3. **Sublease agreements** -- Entering a sublease that extends beyond the current lease term
4. **Market rent changes** -- When a below-market renewal option becomes more valuable due to rent spikes

**Worked Example -- Pinnacle Logistics (fictional)**

Pinnacle has a 5-year warehouse lease with a 3-year extension option (not initially considered reasonably certain). In Year 3, Pinnacle invests $1.2M in automated racking systems.

| Before Reassessment | After Reassessment |
|---|---|
| Lease term: 5 years | Lease term: 8 years (extension now reasonably certain) |
| Remaining payments: 2 × $300K | Remaining payments: 5 × $300K |
| Liability (at 6%): $550,000 | Liability (at 6%): $1,260,000 |
| ROU asset adjusted upward | Increase = $710,000 |

\`\`\`mermaid
flowchart TD
    A[Significant Event Occurs] --> B{Within Lessee Control?}
    B -->|No| C[No Reassessment Required]
    B -->|Yes| D{Changes Reasonable Certainty of Option?}
    D -->|No| C
    D -->|Yes| E[Reassess Lease Term]
    E --> F[Remeasure Lease Liability at Revised Discount Rate]
    F --> G[Adjust ROU Asset by Same Amount]
    G --> H[Prospective Depreciation Over New Remaining Term]
\`\`\`

Important: the revised discount rate used for remeasurement is the rate as of the reassessment date, not the original inception rate. This means rising interest rates will partially offset the liability increase from extending the term. The adjustment is asset-neutral -- no gain or loss hits the income statement; the ROU asset absorbs the full change.

What triggers a reassessment of the lease term under IFRS 16 and how does it affect the liability?

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