the fair value of the asset at the commencement of the lease.
If the revised terms had been in existence at inception then the implicit interest rate and NPV calculation
would have been as follows. This corresponds to (a) above.
Finance charge
Capital sum at
Capital sum
(IIR 4.10%
Capital sum at
Year
start of period
Rental paid
during period
per annum)
end of period
€ €
€
€ €
1 25,000 4,200
20,800
853 21,653
2 21,653 4,200
17,453
715 18,168
3 18,168 4,000
14,168
581 14,749
4 14,749 4,000
10,749
441 11,190
5 11,190 4,000
7,190
294 7,484
6 7,484 4,000
3,484
143 3,627
7 3,627 1,850
1,777
73
1,850
26,250
3,100
Leases (IAS 17) 1665
The NPV of the lessee’s minimum lease payments (per the rentals paid above) discounted at the IIR of 4.1%
is €23,603 which is 94% of the fair value of the asset at the commencement of the lease. The lease would be
classified as a finance lease.
Method (b) results in the following calculation:
Finance charge
Capital sum at
Capital sum
(IIR 5.92%
Capital sum at
Year
start of period
Rental paid
during period
per annum)
end of period
€
€
€
€
€
1 25,000
4,200
20,800
1,231
22,031
2 22,031
4,200
17,831
1,056
18,887
3 17,566
4,000
13,566
803
14,369
4 14,369
4,000
10,369
613
10,982
5 10,982
4,000
6,982
414
7,396
6 7,396
4,000
3,396
201
3,597
7 3,597
1,850
1,747
103
1,850
26,250
4,421
The present value of the total rentals paid over the revised lease term at the original discount rate of
5.92% is €22,585, which is 90.3% of the fair value of the asset at commencement of the lease. In
addition, the residual value of €1,850 would have had a present value of only €1,237; it is a feature of
the methodology that the present value of the lease payments and the present value of the residual do
not add up to the fair value of the asset at inception. In order to make the computation, an adjustment
is made to the capital amount as at the date that the lease is renegotiated. The outstanding amount is
recomputed from €18,887 (the balance at the end of year 2 calculated using the original assumptions)
to €17,566, the amount that corresponds to the new assumptions. Note that it is not relevant that the
method results in a change to the ‘capital sum’ of only 7% ((18,887 – 17,566) ÷ 18,887). The
assessment is based on the net present value of the minimum lease payments over the lease term and
other features of the revised agreement.
If method (c) is applied, the modified lease is considered as if it were a new five year lease. The IIR calculated
prospectively over the remaining term is now 6.13%:
Finance charge
Capital sum at
Capital sum
(IIR 6.13%
Capital sum at
Year
start of period
Rental paid
during period
per annum)
end of period
€
€
€
€
€
3 17,500
4,000
13,500
827
14,327
4 14,327
4,000
10,327
633
10,960
5 10,960
4,000
6,960
426
7,386
6 7,386
4,000
3,386
207
3,593
7 3,593
1,850
1,743
107
1,850
17,850
2,200
The present value of the remaining rental payments to be made discounted at the IIR of 6.13% is €16,126,
which is 92.15% of the fair value of the asset (€17,500) at the date of entering into the new lease.
In this example, all three methods result in a present value of the minimum lease payments that exceeds 90%
but this would not, of course, always be the case.
1666 Chapter 23
6.1.2
Accounting for reclassified leases
IAS 17 states that the revised agreement is treated as a new agreement over its term.
If the original lease was a finance lease and the revised lease is an operating lease,
then the balances relating to the finance lease must be derecognised. For the
lessee, this involves derecognising both the asset (which will have been
depreciated up to the point of derecognition over the shorter of the useful life or
the lease term) and the finance lease liability. Finance lease derecognition is
discussed further at 4.3 above.
If the original lease was an operating lease and the revised lease is a finance lease, then
any balances resulting from recognising the lease cost on a straight-line basis will be
expensed and the balances relating to the finance lease must be recognised for the first
time unless payments made under the original operating lease affect the terms of the
new finance lease. For example, an entity might have made an up-front prepayment
under the terms of the original lease of which part relates to the period after the
renegotiation. This is taken into account in the revised terms and becomes a
prepayment over the relevant period under the new finance lease.
Although the standard says that ‘the revised agreement is regarded as a new agreement
over its term’, [IAS 17.13], this refers to classification; there is no consensus regarding the
measurement of assets and liabilities as at this point.
• The revised lease may be accounted for as a new lease as from the date on
which the terms were changed, based on an implicit interest rate modified to
reflect the revised lease term and revised cash flows (method (a) in 6.1.1 above)
or the revised lease term, cash flows, and the fair value of the assets as at the
date of revision (method (c) in 6.1.1 above). In the facts as in Example 23.23
above, the assets and liabilities under the finance lease would be recognised
initially as;
• €16,655, being the present value of the revised remaining lease payments
applying method (a) from 6.1.1 above; or
• €16,126, being
the present value of the revised remaining lease payments
applying method (c) from 6.1.1 above.
• The new lease can be recognised using method (b) above, by taking into
consideration the changes in the agreement but calculating the present value
of the asset and liability by using the interest rate implicit in the original lease.
This uses an accepted methodology and is consistent with the fact that there
has, in fact, only been a change to the original terms and not a completely new
lease; it also has the advantage that the revised fair value of the assets does not
have to be known.
In the facts as in Example 23.23 above, this means that the asset and liability would
be recorded at €16,178.
If the original lease agreement and the revised lease agreement are both finance leases,
then the modification will have accounting consequences that are discussed in the
following section.
Leases (IAS 17) 1667
6.1.3
Accounting for modifications to finance leases
If the rights under a finance lease have changed without a change in the classification,
these changes to lease term and cash flows must be accounted for. Once again, the
accounting consequences are not dealt with by IAS 17.
The two most obvious methods of calculating the impact of the changes are as follows:
(a) Account for the revised agreement as if it were a new lease, even though the
classification has not changed. The calculation will be based on the fair value and
useful life of the asset at the date of the revision.
(b) Use the original IIR to discount the revised minimum lease payments and (for a
lessee) adjust any change in lease liability to the carrying amount of the asset.
Lessors will adjust the carrying value of the asset, taking gains or losses to income.
As noted before, this approach is consistent with the requirements of IFRS 9 when
the effective interest rate method is applied and the cash flows change. [IFRS 9.5.4.3].
These are described in 6.1.1 and Example 23.23 above (method (b) and method (c)). For
lessees, both of these methods will affect the carrying value of the asset and hence its
future amortisation.
Another method that might be considered is to reflect changes prospectively over the
remaining term of the lease; this is only likely to be appropriate if the cash flows are
modified but all other rights remain unchanged. Some of the circumstances in which
such changes can arise are considered at 6.1.4 below.
Example 23.24: Accounting for lease modifications
The details of a lease are as in Example 23.23 above, except that the lease has an original duration of six
years with an annual rent of €4,200, rather than five years. The present value of the minimum lease payments
based on the total rental paid discounted using the IIR of 5.92% is €21,931, which is 87.72% of the fair value
of the leased asset, calculated as follows:
Finance charge
Capital sum at
Capital sum
(IIR 5.92%
Capital sum at
Year
start of period
Rental paid
during period
per annum)
end of period
€ €
€
€ €
1 21,931 4,200
17,731
1,050 18,780
2 18,780 4,200
14,580
863 15,443
3 15,443 4,200
11,243
666 11,909
4 11,909 4,200
7,709
456 8,165
5 8,165 4,200
3,965
235 4,200
6 4,200 4,200
–
–
–
25,200
3,270
The directors of the entity assess this as a finance lease, taking account of all of the circumstances surrounding
the agreement. The entity capitalise the asset at €21,931 at commencement of the lease and recognise an
equivalent liability.
At the end of year 2, the lease term is extended for a further year, making the term seven years in total.
Payments for the four years 3-6 are reduced to €4,000 and €1,850 is payable for year 7.
1668 Chapter 23
The asset (which has a useful life to the lessee of six years) has been depreciated on a straight-line basis for two
years and its carrying amount is €14,620, while the lessee’s lease liability (as calculated above) is €15,443:
(a) If the modification is treated as a new lease, it will be accounted for as follows, using the revised fair
value of €16,126 and IIR of 6.13% calculated at Example 23.23(c) above:
Finance charge
Capital sum at
Capital sum
(IIR 6.13%
Capital sum at
Year
start of period
Rental paid
during period
per annum)
end of period
€ €
€
€ €
3 16,126 4,000
12,126
743 12,868
4
12,868 4,000
8,868
543 9,412
5 9,412 4,000
5,412
331 5,743
6 5,743 4,000
1,743
107 1,850
7 1,850 1,850
–
– –
17,850
1,724
Therefore, the entity will derecognise both the leased asset of €14,620 and liability of €15,443, recognising
a net gain of €823. The new asset of €16,126 will be depreciated prospectively over the remaining life of
5 years.
(b) If the modification is accounted for by restating the liability using the original IIR of 5.92%, the liability
will be €16,178 calculated as follows:
Finance charge
Capital sum at
Capital sum
(IIR 5.92%
Capital sum at
Year
start of period
Rental paid
during period
per annum)
end of period
€ €
€
€ €
3 16,178 4,000
12,178
721 12,899
4 12,899 4,000
8,899
526 9,425
5 9,425 4,000
5,425
322 5,747
6 5,747 4,000
1,747
103 1,850
7 1,850 1,850
–
– –
17,850
1,672
The entity will increase the lease liability by €735 (from €15,443 to €16,178) but it will increase the asset’s
carrying amount by the same amount from €14,620 to €15,355 which will be depreciated prospectively over
the asset’s remaining life of 5 years.
6.1.4
Tax and interest variation clauses
The relationship between leasing and taxation is frequently complex. It depends on
whether tax deductions or taxable income are based on amounts receivable or payable
in accordance with the lease or on the amounts that are taken to the income statement.
It further depends on the availability of tax deductions for the cost of leased assets and
who is able to claim these deductions. Some lessors draw up leases that are based on a
post-tax retur
n that takes account of these factors. These leases include tax variation
clauses that enable lessors to change the amounts receivable from the lessee so that
their post-tax return remains constant. The rental could be adjusted in a number of
different ways, e.g. a new fixed payment, an up-front sum or an adjustment on a rental-
by-rental basis.
The variations are unlikely of themselves to change the lease classification because their
potential impact will have been taken into account in making that original assessment.
Leases (IAS 17) 1669
Nor are they likely to lead to an impairment of a lessor’s finance lease asset as the
profitability of the lease (on a post-tax basis) is unaffected.
IAS 17 does not refer to variation clauses so the question is whether the change is a
variety of contingent rent, defined by the standard as that portion of the lease payments
that is not fixed in amount but is based on a factor that varies other than with the passage
of time, such as percentage of sales, amount of usage, price indices or market rates of
interest, [IAS 17.4], or another type of event. Contingent rent is recognised when it is
incurred. This means that a reduction in rentals because of a reduction in rates of
taxation would be a negative contingent rent.
Leases may also contain interest variation clauses which adjust the rental by reference
to movements in bank base rates or similar. As market rates of interest are specific
examples of contingent rent in the standard, they must be accounted for as such. These
movements could be positive or negative over the lease term.
6.1.5
Accounting for changes to the terms of operating leases
Lessees may seek to renegotiate terms with lessors, e.g. in circumstances in which the
lessee has financial difficulties or where there is evidence that the lease terms are at
higher than market rates or to extend the lease term while, at the same time, changing
the payments made under the lease agreement. If the revised lease is still classified as
an operating lease, the revised terms should be taken into account prospectively from
the date of the agreement.
The lessee now has a contractual obligation to continue the lease and the effect
on any existing straight-line prepayment or accrual should be taken into account.
Both previously recognised amounts and aggregate future minimum lease
International GAAP® 2019: Generally Accepted Accounting Practice under International Financial Reporting Standards Page 329