IFRS 16 Lease Modifications: How to Account for and Audit Them

When IFRS 16 requires modification accounting

The client extended a warehouse lease by four years and negotiated a 12% rent reduction for the extended term. Your senior booked it as a new lease. The manager thinks it should be a remeasurement of the existing lease. They’re both partially right, and the file currently reflects neither answer correctly. IFRS 16.44 makes the accounting treatment depend on two conditions, and getting the classification wrong cascades into every subsequent period.

IFRS 16.44 defines a lease modification as a change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions. The definition is broad. It catches rent renegotiations, term extensions, early terminations, additions of floor space, and changes to purchase options.

If the lease contract has been amended in a way that changes what the lessee pays or what the lessee gets, you are in modification territory.

What it does not catch: changes already embedded in the original contract. A rent escalation clause that increases payments by CPI each year is not a modification. An option to extend that was included at inception and is now being exercised is not a modification either (although exercising it may trigger a reassessment of the lease term under IFRS 16.20–21, which has a similar but distinct accounting effect). The distinction matters because the remeasurement triggered by a reassessment uses the original discount rate, while a modification remeasurement uses a revised rate. A practical test: was the contract physically amended, or did a new side-letter or addendum get signed? If yes, it’s almost certainly a modification. Where the change flows from the original terms without any new agreement, it’s more likely a reassessment.

The two-condition test: separate lease or remeasurement?

IFRS 16.44 gives you two conditions. Both must be met for the modification to be accounted for as a separate lease.

Condition 1: the modification increases the scope of the lease by adding the right to use one or more additional underlying assets. Adding a second floor to an existing office lease meets this. Extending the term of an existing lease does not, because a term extension grants more time with the same asset, not access to an additional asset. This is the condition that eliminates the majority of common modifications (rent reductions, term extensions, early terminations) from separate-lease treatment.

Condition 2: the consideration for the lease increases by an amount commensurate with the standalone price of the additional right of use, adjusted for the circumstances of the contract. “Commensurate with the standalone price” means the client is paying a market rate for the additional space. If the landlord gives a volume discount on the new floor because the tenant is already leasing four other floors, that discount means the price is not commensurate, and the modification fails the second condition.

Very few modifications qualify as separate leases in practice. The most common modification types (extending term, reducing scope, changing rent) fail Condition 1 because they don’t add a new underlying asset. This means the vast majority of modifications flow through the remeasurement route.

Remeasurement mechanics for modifications that are not a separate lease

When a modification fails the separate-lease test, IFRS 16.45 requires the lessee to remeasure the lease liability on the effective date of the modification. The remeasurement has two components.

First, determine the revised lease payments. These are the payments the lessee expects to make under the modified terms from the modification date forward. For a term extension, include the payments for the extended period. A rent change means using the new rent figure. And if both changed simultaneously (as in the Dekker example below), apply both adjustments together.

Second, discount those revised payments at a revised discount rate. IFRS 16.45(c) requires a revised rate determined at the effective date of the modification. This is the rate implicit in the modified lease if readily determinable. If not (and it usually isn’t), use the lessee’s incremental borrowing rate at the modification date. The rate at inception is no longer relevant. This is one of the most commonly missed steps. Teams carry forward the original discount rate because they’ve already built their amortisation schedule on it. The standard is explicit: the rate must be revised.

The difference between the remeasured lease liability and the previous carrying amount of the lease liability is adjusted against the right-of-use asset. No gain or loss hits the income statement for modifications that increase scope or extend term. The ROU asset absorbs the change in the liability.

An exception exists for rent decreases and partial terminations, covered in the next section.

Scope decreases and partial terminations

IFRS 16.46(a) handles modifications that decrease the scope of the lease. If the client surrenders one floor of a three-floor office lease, or terminates a lease early for part of the space, the accounting is different from a pure extension or rent increase.

For the portion of the lease that has been terminated, the lessee decreases the carrying amount of the right-of-use asset to reflect the partial termination and recognises any difference between the ROU reduction and the corresponding lease liability reduction in profit or loss. This is the one scenario where a modification can generate a gain or loss in the income statement.

For the remaining portion, the lessee remeasures the lease liability using the revised payments and a revised discount rate, then adjusts the ROU asset for that continuing portion as described above (no P&L impact on the continuing part).

The practical difficulty is splitting the ROU asset and lease liability between the terminated portion and the continuing portion. IFRS 16.46(a) requires the split on a proportionate basis (for example, by floor area if the modification surrenders physical space). Document the allocation basis and the calculation. Auditors should verify that the proportionate basis reflects the economic substance of what was surrendered, not just the contractual description.

Full early termination is mechanically simpler. If a client terminates an entire lease before the end of its term (not a partial termination but a complete exit), the entire remaining ROU asset and lease liability are derecognised, and any difference goes to profit or loss. This happens less frequently than partial modifications but is cleaner to account for.

Worked example: Dekker Machinebouw B.V.

Scenario: Dekker Machinebouw B.V. leases a production facility in Eindhoven. The original lease commenced 1 January 2022 with a 6-year term at €300,000 per year (paid at year-end). The discount rate at inception was 3.8%. On 1 January 2025 (three years into the lease), Dekker and the landlord agree to extend the lease by four years (to 31 December 2031) and reduce the annual rent to €265,000 for the extended term. No additional assets are added. Dekker’s incremental borrowing rate at the modification date is 5.1%.

Step 1: Apply the two-condition test (IFRS 16.44)

Condition 1 asks whether the modification adds a right to use an additional underlying asset. It does not. The modification extends the term of the existing facility and changes the rent. No new asset is involved. Condition 1 is not met.

Because Condition 1 fails, there is no need to evaluate Condition 2. This modification is not a separate lease. It flows through the remeasurement route under IFRS 16.45.

Step 2: Determine the carrying amounts immediately before modification

At 1 January 2025, three years of the original six-year lease have elapsed. The remaining lease term under the original contract is three years (2025, 2026, 2027) at €300,000 per year.

Lease liability before modification: PV of three remaining payments at 3.8%

= €300,000 × annuity factor at 3.8% for 3 years = €300,000 × 2.7751 = €832,530

ROU asset before modification: The original ROU asset was €1,665,060 (PV of six payments at 3.8% = €300,000 × 5.5502). After three years of straight-line depreciation (€277,510 per year), the carrying amount is:

= €1,665,060 − (3 × €277,510) = €1,665,060 − €832,530 = €832,530

Step 3: Remeasure the lease liability at the modification date

After the modification, the remaining lease term is seven years (2025 through 2031) at €265,000 per year. The revised discount rate is 5.1% (Dekker’s incremental borrowing rate at the modification date).

Revised lease liability = €265,000 × annuity factor at 5.1% for 7 years = €265,000 × 5.7864 = €1,533,396

Step 4: Adjust the right-of-use asset

Change in lease liability = €1,533,396 − €832,530 = €700,866 increase

The ROU asset is adjusted by the same amount.

Revised ROU asset = €832,530 + €700,866 = €1,533,396

Step 5: Record the journal entry on modification date (1 January 2025)

No cash changes hands on the modification date. The entry reflects the remeasurement of future obligations and the corresponding asset adjustment.

Step 6: Verify subsequent measurement for the first year post-modification

Depreciation for 2025: €1,533,396 ÷ 7 = €219,057

Interest expense for 2025: €1,533,396 × 5.1% = €78,203

Lease payment for 2025: €265,000

Lease liability at 31 December 2025: €1,533,396 + €78,203 − €265,000 = €1,346,599

A reviewer checking this file would see the two-condition assessment, the pre-modification carrying amounts, the revised discount rate justification, the remeasured liability, the ROU adjustment, the day-one journal entry, and the post-modification amortisation schedule. That gives a complete trail from the contract amendment to the financial statements.

Reassessment versus modification: the distinction that matters for the discount rate

This is one of the most common sources of confusion, so it’s worth isolating. IFRS 16 uses two different triggers for remeasuring a lease liability, and they produce different discount rate outcomes. A modification (IFRS 16.44–46) occurs when the parties agree to change the lease terms through a new agreement. It requires a revised discount rate at the modification date.

A reassessment (IFRS 16.20–21, IFRS 16.36(c), IFRS 16.40) is different. It occurs when existing lease terms trigger a change without a new agreement. The most common example is the exercise of an extension option that was included in the original lease. IFRS 16.42 requires the lessee to remeasure using a revised rate when reassessing the lease term or a purchase option, but IFRS 16.42(b) permits the original rate for reassessments triggered by changes in amounts expected to be payable under residual value guarantees or changes in future lease payments resulting from a change in an index or rate.

In practice, the question is this: was a new document signed? If the landlord and tenant signed an addendum extending the lease by four years and reducing the rent, that’s a modification (revised rate). If the tenant exercised a pre-existing five-year renewal option already embedded in the original contract, that’s a reassessment (revised rate in this case too, per IFRS 16.42(a), because the lease term changed). But if the only change is that CPI moved the annual rent from €265,000 to €271,000 under an existing escalation clause, that’s a reassessment where the original rate is used.

Getting this wrong doesn’t change the lease payments used in the remeasurement, but it changes the discount rate, which changes the remeasured liability, which changes the ROU asset. On Dekker’s numbers, the spread between the 3.8% inception rate and the 5.1% modification rate produced a €700,866 adjustment. Using the wrong rate would misstate the ROU asset and the lease liability by tens of thousands of euros, potentially enough to cross materiality on a mid-market engagement.

If your client has a portfolio of leases and some were modified while others had extension options exercised in the same period, you may have both modifications and reassessments to process. Each lease needs its own analysis. A blanket approach of using the current borrowing rate for every remeasurement will be correct for the modifications but wrong for index-linked reassessments.

The IFRS 16 lease calculator allows you to input either the original or revised rate. Make sure you select the correct one based on whether you are processing a modification or a reassessment.

Practical checklist for your current engagement

1. Confirm the modification date (the date both parties agree to the modification, per IFRS 16.44). This is the date the remeasurement is performed, not the date the modified rent starts or the date the addendum was physically signed.
2. Apply the two-condition test in IFRS 16.44 and document both conditions in the working paper, even if the modification clearly fails Condition 1. A blank assessment on Condition 2 will draw a review note.
3. Verify the revised discount rate. IFRS 16.45(c) requires a rate determined at the modification date. If the team is still using the original inception rate, the lease liability is misstated. Check the IFRS 16 lease calculator output against the rate the client used.
4. For scope decreases and partial terminations, verify the allocation basis for splitting the ROU asset and lease liability between the terminated and continuing portions (IFRS 16.46(a)). Floor area and standalone rental values are the two most defensible bases.
5. Check whether the modification date falls within the current or prior period. If the contract was amended in the prior year but the client didn’t perform the remeasurement until the current year, there may be a prior period adjustment to consider under IAS 8.
6. Build or obtain the post-modification amortisation schedule. Verify that it starts from the remeasured lease liability, uses the revised discount rate, and reconciles to nil at the end of the modified lease term.

Common mistakes

• Using the original discount rate instead of a revised rate at the modification date. IFRS 16.45(c) requires a revised rate for modifications that are not accounted for as a separate lease. The AFM’s 2020 IFRS 16 thematic review noted discount rate errors as a recurring finding across lease portfolios, including modification remeasurements.
• Treating a term extension as a separate lease. A term extension grants more time with the same asset, not access to an additional underlying asset. It fails Condition 1 of the IFRS 16.44 test and must be accounted for as a remeasurement.
• Failing to recognise a gain or loss on a partial termination. When the scope of the lease decreases, IFRS 16.46(a) requires the lessee to reduce the ROU asset proportionately and recognise any difference between the ROU reduction and the corresponding lease liability reduction in profit or loss. Teams sometimes adjust the ROU asset without running this calculation, burying a P&L item in the balance sheet.

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Frequently asked questions

Further reading and source references

• IFRS 16, Leases: paragraphs 44–46 cover modification accounting. Paragraphs 20–21 and 36–42 cover reassessment triggers and the discount rate rules for each.
• IFRS 16.BC161: the IASB’s basis for requiring a revised discount rate on modification versus permitting the original rate for certain reassessments.
• AFM 2020 IFRS 16 thematic review: findings on discount rate errors in lease modification remeasurements.
• ESMA 2023 European Common Enforcement Priorities: enforcement findings flagging lease modification discount rate errors as a recurring issue.
• IFRS 16 lease accounting: Ciferi glossary entry covering the core recognition and measurement requirements that modification rules build on.