In one of our previous AASB 16 Check articles, we explained how lease payments that are linked to an index such as the Consumer Price Index (CPI) are included in the lease liability. Here, we extend that scenario to include an additional escalation clause, namely, a market rent review during the lease term. In this issue of AASB 16 Check we consider how a market rent review might impact the re-measurement of the lease liability.
Scenario
Let’s pose a scenario that a company rents office space in a building for a period of seven years, with annual lease payments of $100,000, payable at the beginning of each year. Lease payments vary as follows:
- For Years 2 to 4, lease payments are indexed annually at the beginning of the year for the change in the CPI for the preceding year
- Lease payment in Year 5 is subject to market rent review
- For Years 6 to 7, lease payments are indexed annually at the beginning of the year for the change in the CPI for the preceding year.
As a result of the change in CPI from commencement to the end of Year 1, the lease payment for Year 2 is determined to be $102,000.
Interpretive response: The lessee remeasures the lease liability when the next amount payable is fixed. In this case, when the change in CPI is known at the beginning of Year 2, where the amount payable for Year 2 is determined to be $102,000.
All subsequent lease payments (Years 3 to 7) are also adjusted to reflect the updated payment.*
The lease liability is remeasured to the present value of the following amounts:
| Year 2 | $102,000 |
| Year 3 | $102,000 |
| Year 4 | $102,000 |
| Year 5 | $102,000 |
| Year 6 | $102,000 |
| Year 7 | $102,000 |
As the amounts relate to Years 2 to 7, the change is recognised as an adjustment to the right-of-use asset. That is, the resulting change in the lease liability of $12,000 – ignoring discounting [($102,000 X 6) – 600,000] is adjusted against the ROU asset.
This remeasurement process is repeated at the beginning of each year when the amount payable for the next period is known.
Alternate scenario
Let’s pose an alternate scenario where the lease payments vary as follows:
- For Years 2 to 4, lease payments are indexed annually at the beginning of the year at a fixed rate of 2%
- Lease payment in Year 5 is subject to market rent review
- Lease payments in Year 6 and 7 based are based on the lease payment for Year 5.
Interpretive response: At commencement, the lessee measures the lease liability at the present value of the following amounts:
| Year 1 | $100,00 |
| Year 2 | $102,000 |
| Year 3 | $104,000^ |
| Year 4 | $106,000^ |
| Year 5 | $100,000 |
| Year 6 | $100,000 |
| Year 7 | $100,000 |
^ rounded
At commencement date, the lease payment for Year 5 is measured as the lease payment amount at commencement as it is subject to a market rent review*, and is therefore only remeasured when the amount payable is fixed. In this case, when the market rent review is known at the beginning of Year 5.
Interpretive response: At the beginning of Year 5 the market rent review results in an adjustment of the lease payment to $120,000. The lessee therefore remeasures the lease liability at the beginning of Year 5. All subsequent lease payments (Years 6 and 7) are also adjusted to reflect the updated payment.
The lease liability is remeasured to the present value of the following amounts:
| Year 5 | $120,000 |
| Year 6 | $120,000 |
| Year 7 | $120,000 |
In technical speak
A lessee shall remeasure the lease liability by discounting the revised lease payments if there is a change in future lease payments resulting from a change in an index or a rate used to determine those payments, including for example a change to reflect changes in market rental rates following a market rent review. The lessee shall remeasure the lease liability to reflect those revised lease payments only when there is a change in the cash flows (ie when the adjustment to the lease payments takes effect). A lessee shall determine the revised lease payments for the remainder of the lease term based on the revised contractual payments. [AAASB 16.42(b)]
* Variable lease payments subject to CPI are treated in a similar manner as those subject to market rent review as they are both variable lease payments subject to an index or rate under AASB 16.
If you would like to discuss the application of the standard for your organisation, please contact us.
More AASB 16 Check
- How does a borrower account for a waiver of loan repayments?
- How does a borrower account for loan repayment holidays obtained during the COVID-19 pandemic?
- When do loan modifications result in derecognition?
- How does a borrower account for a modification to a prepayable fixed rate loan?
- What is the impact of modifying a floating rate loan?
- How do new costs and fees impact modification accounting?
- Does the effective interest rate change with non-substantial loan modifications?
- How does a borrower account for loan renegotiation costs?
- How are unamortised transaction costs accounted for on loan modification?
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