Theory and Practice
If the lessee changes its assessment of whether it will exercise an extension or termination option (i.e. the lease term changes), IFRS, US GAAP and UK GAAP require remeasuring the lease liability to reflect the new term (using an updated discount rate as of the date of change). The ROU asset is adjusted by the same amount. No immediate Income Statement impact arises at remeasurement (unless the ROU asset is reduced below zero). Under US GAAP, the lease’s classification is also reassessed at the remeasurement date (e.g., an operating lease could become a finance lease prospectively if the extended term now meets finance lease criteria).
Apart from explicit modifications, IFRS and US GAAP require lessees to reassess certain key estimates or decisions over the lease term and adjust accounting accordingly:
Lease term and options: If a lessee changes its assessment of lease term – for example, now intends to exercise an extension option that it originally judged as not reasonably certain – then the lease liability and ROU asset must be remeasured. IFRS 16 and ASC 842 both mandate remeasurement when there is a change in whether the lessee is reasonably certain to exercise (or not exercise) an extension or termination option (IASB, 2016; Financial Accounting Standards Board, 2016b). The lessee uses a revised discount rate as of the date of the change and updates the liability to reflect payments over the revised term, with a corresponding adjustment to the ROU asset. The same applies if the lessee becomes or ceases to be reasonably certain to exercise a purchase option (buyout option). For instance, if after three years of a five-year lease the lessee now plans to extend for a further five-year optional term (when initially it wasn’t planning to), the lessee remeasures the lease over the ten-year total term. Under IFRS, this is done when the change in certainty occurs. Under US GAAP, the timing is the same – when the lessee’s judgment changes, it remeasures (and also reassesses classification as part of a “modified lease” as noted above).
Residual value guarantees (RVGs): If a lessee has guaranteed the lessor a certain asset value at lease end, the accounting is similar under both standards. Initially, the lessee includes the expected payment under the guarantee in the lease liability (to the extent payment is expected). If expectations change (e.g., the asset’s estimated end-of-lease value declines further, making it more likely the lessee will owe under the guarantee), the lessee remeasures the lease liability to reflect the higher expected payment (and increases the ROU asset) (IASB, 2016; Financial Accounting Standards Board, 2016b). Conversely, if it becomes apparent the liability will be lower than originally estimated, the lessee reduces the liability and ROU asset. These adjustments happen under the same rules as modifications (IFRS treats it as a remeasurement with updated discount rate; US GAAP similarly remeasures when a change in estimate occurs that is not a contract modification).
Other remeasurements: IFRS 16 requires lessees to remeasure the lease liability when an index or rate changes, as discussed in Appendix A.3 (IASB, 2016). US GAAP does not remeasure for index changes alone, treating those as period expenses (Financial Accounting Standards Board, 2016b). Both IFRS and GAAP require remeasurement when a contingency is resolved such that variable payments become fixed (e.g., a usage threshold is reached converting variable rent to fixed rent for the remainder of the term – at that point, the now-fixed payments would be included in the liability). US GAAP explicitly mentions to remeasure if a contingency upon which variable payments are based is resolved so that those payments become fixed (Financial Accounting Standards Board, 2016b). IFRS implies the same through the principle of remeasurement when cash flows change. In summary, IFRS demands more frequent updating of leases for changes (even purely market-driven ones like inflation), whereas US GAAP tries to avoid remeasurement except for significant modifications or events like option exercise or classification changes (RSM US LLP, 2020).