Key Points
- Only variable payments tied to an index or rate (such as CPI or EURIBOR) are included in the initial lease liability measurement at commencement.
- Variable payments linked to usage or performance (revenue-based rent, per-unit charges) are expensed as incurred and never appear in the lease liability.
- Misclassifying a usage-based payment as index-linked overstates the lease liability and the paired right-of-use asset from day one.
- Lessees remeasure the liability for index-linked payments only when the cash flows actually change (for example, at each CPI reset date), not at every reporting date.
What is Variable Lease Payments?
IFRS 16.27(a) splits variable lease payments into two categories. Payments that depend on an index or a rate (CPI adjustments, EURIBOR-linked escalations) form part of the lease liability at commencement, measured using the index or rate as at that date. Payments that depend on usage or performance (revenue-percentage rent, per-kilometre charges on vehicle fleets) sit outside the liability entirely. The lessee recognises them in profit or loss in the period the triggering event occurs (IFRS 16.38(b)).
The distinction has balance-sheet consequences. Index-linked payments inflate the right-of-use asset and lease liability at commencement because IFRS 16.27(a) requires the lessee to include them using the prevailing index value. Usage-based payments leave both balances untouched. When the index resets (a CPI adjustment taking effect on an anniversary date, for instance), IFRS 16.42(b) requires the lessee to remeasure the liability using the revised cash flows but retain the original discount rate. The adjustment flows through the right-of-use asset, not through profit or loss.
ISA 540.13(a) requires the auditor to evaluate whether the entity's method for measuring the lease liability is appropriate. For variable payments, that means verifying the classification of each payment stream and confirming that management applied the correct index value at commencement and at each subsequent reset.
Worked example: Fernandez Distribucion S.L.
Client: Spanish wholesale distribution company, FY2025, revenue EUR 34M, IFRS reporter. Fernandez leases a 3,800 m² distribution warehouse in Valencia under a seven-year lease commencing 1 January 2025. The lease requires a base annual payment of EUR 210,000 (payable in arrears), an annual CPI escalation clause applying from year two, and an additional charge of 1.5% of warehouse throughput revenue. Fernandez's incremental borrowing rate at commencement is 4.0%. CPI at commencement stands at 117.2.
Step 1 — Classify each payment stream
The base payment of EUR 210,000 is a fixed payment. The CPI escalation is a variable payment linked to an index. The 1.5% throughput charge is a variable payment linked to performance. IFRS 16.27(a) requires inclusion of the fixed payment and the index-linked component; the performance-linked charge is excluded from the liability.
Step 2 — Measure the lease liability at commencement
Because the CPI escalation has not yet reset, IFRS 16.27(a) requires measurement using the index at the commencement date. The initial annual payment remains EUR 210,000 for all seven years (no assumed future CPI increases). The present value of seven annual payments of EUR 210,000 in arrears at 4.0% is EUR 1,261,136.
Step 3 — Recognise the performance-linked charge in year one
Fernandez's warehouse throughput revenue for FY2025 is EUR 9.4M. The 1.5% charge produces an expense of EUR 141,000, recognised in profit or loss when incurred per IFRS 16.38(b). This amount does not affect the lease liability or the right-of-use asset.
Step 4 — Remeasure for the CPI reset at 1 January 2026
CPI has risen from 117.2 to 120.8 (a 3.07% increase). The revised annual payment is EUR 210,000 multiplied by 120.8 / 117.2, giving EUR 216,442. The lessee remeasures the liability as the present value of six remaining payments of EUR 216,442 at the original discount rate of 4.0%, producing a revised liability of EUR 1,135,884. The difference between the pre-remeasurement carrying amount and EUR 1,135,884 adjusts the right-of-use asset per IFRS 16.42(b).
Conclusion: the initial lease liability of EUR 1,261,136 excludes the throughput-based charge entirely, and the CPI remeasurement at the first reset date is defensible because it uses a published index and retains the original discount rate as IFRS 16 requires.
Why it matters in practice
Teams frequently include forward-looking CPI projections in the initial lease liability measurement. IFRS 16.27(a) requires the lessee to measure index-linked payments using the index as at the commencement date. Projecting future inflation into the day-one liability overstates both the right-of-use asset and the lease liability, and ISA 540.13(b) requires the auditor to evaluate whether the data inputs match the standard's requirements.
Usage-based and performance-based variable payments are sometimes capitalised into the right-of-use asset through an estimated average. IFRS 16.B42 explicitly excludes these payments from the liability and from the asset. The lessee expenses them as incurred. Capitalising an estimate introduces a measurement that IFRS 16 does not permit.
Variable lease payments vs. in-substance fixed payments
| Dimension | Variable lease payments | In-substance fixed payments |
|---|---|---|
| Definition | Payments that genuinely vary based on an index, rate, usage, or performance | Payments structured as variable but that are unavoidable in substance (e.g., a minimum floor that will always be triggered) |
| Lease liability treatment | Index-linked: included at commencement-date value. Usage-based: excluded entirely. | Always included in the lease liability as if they were fixed payments (IFRS 16.B42) |
| Remeasurement trigger | Index resets trigger remeasurement of the liability under IFRS 16.42(b) | No separate remeasurement trigger; treated identically to fixed payments |
| Common audit issue | Misclassifying a usage-based charge as index-linked | Failing to identify that a nominally variable payment has a floor making it unavoidable |
| P&L impact | Usage-based charges hit profit or loss when incurred; index adjustments flow through the right-of-use asset | Fully embedded in depreciation and interest from commencement |
The distinction matters because in-substance fixed payments masquerading as variable charges keep liabilities off the balance sheet if the auditor does not scrutinise the contract terms. IFRS 16.B42 requires judgment on whether a payment that appears variable is economically unavoidable.
Related terms
Frequently asked questions
Do variable lease payments linked to CPI use the original or a revised discount rate on remeasurement?
The lessee retains the original discount rate. IFRS 16.42(b) specifies that when variable payments change because of an index or rate adjustment, the revised cash flows are discounted at the unchanged rate from the commencement date. A revised discount rate applies only when the lease term changes or a purchase option assessment changes under IFRS 16.40.
How do I account for a lease with both index-linked and revenue-based variable payments?
Split the payments at commencement. Include the index-linked component in the lease liability using the index value at the commencement date per IFRS 16.27(a). Expense the revenue-based component in profit or loss when it arises per IFRS 16.38(b). The two streams follow different measurement paths and must be tracked separately throughout the lease.
Does a CPI-linked lease payment require remeasurement at every reporting date?
Only when the cash flows actually change. If the lease contract resets the CPI adjustment annually on an anniversary date, the lessee remeasures the liability at that reset date (IFRS 16.42(b)). No remeasurement occurs at interim reporting dates between resets, even if the published CPI has moved.