IFRS 16 Lease Modifications: Every Scenario Explained with Journal Entries

What counts as a lease modification under IFRS 16?

A lease modification is a change in the scope of a lease, or in the consideration for a lease, that was not part of the original terms and conditions of the contract. That definition sits in IFRS 16 Appendix A, and it is the gateway to the whole modification model: if a change was already contemplated by the contract, it is not a modification at all. Adding or removing an underlying asset, extending or shortening the term, and re-pricing the rent by agreement are all modifications; exercising an option or applying an index reset the contract already contained is not.

Once you confirm a change meets the Appendix A definition, IFRS 16.44-46 governs the accounting. IFRS 16.44 asks a single gating question - is this a separate lease? - and IFRS 16.45-46 tells you what to do when the answer is no. There is no free choice here; the branch is determined by the facts of the renegotiation, and each branch produces a materially different set of numbers for the lease liability and the ROU asset.

Modification vs. reassessment

The most common error is confusing a modification with a reassessment, because they can look identical on the face of a rent schedule. A reassessment (IFRS 16.39-43) updates an estimate the contract already contemplated - for example, the lease term changes because a renewal option becomes reasonably certain (16.40), or payments move on an index reset (16.42). A modification (16.44-46) is a fresh bargain: the parties agree something the original contract did not provide for. The distinction matters for the discount rate. A reassessment under 16.42 uses the unchanged discount rate; some reassessments under 16.40-41 and every non-separate modification under 16.45 use a revised rate. Misfiling one as the other is a classic misstatement.

When is a modification a separate new lease?

A modification is a separate lease only when both conditions in IFRS 16.44 are met: the modification increases the scope of the lease by adding the right to use one or more underlying assets, and the consideration increases by an amount commensurate with the stand-alone price for that increase in scope (adjusted for the circumstances of the contract). Meet both and you have, in substance, signed a second lease - so you leave the original lease untouched and recognise the new component as a brand-new lease with its own commencement date, its own liability, and its own ROU asset (IFRS 16.44).

The commensurate-price test is where judgement bites. Adding 500 sq m of adjacent warehouse space at the going market rent per square metre is a separate lease; adding the same space at a steep bundled discount is not, because the price is not commensurate with its stand-alone value. If either limb of IFRS 16.44 fails - the scope does not increase, or the price is not commensurate - the change is a non-separate modification and falls into IFRS 16.45-46. Splitting a single agreement is legitimate and often required: a rent renegotiation plus a genuinely stand-alone-priced extra floor is part remeasurement, part separate lease.

Separate lease (IFRS 16.44 met). A retailer leases a store. The landlord offers adjacent rooftop plant space at £50k a year, which independent evidence shows is its market stand-alone price. Scope increases and the price is commensurate, so the rooftop is a new separate lease. The original store lease is not remeasured.

Not a separate lease (IFRS 16.44 failed). The same retailer adds more shelving space inside the existing unit at a discounted internal rate below market. The price is not commensurate with a stand-alone price, so this is a single non-separate modification remeasured under IFRS 16.45-46(b).

How do you account for a modification that is not a separate lease?

For a modification that is not a separate lease, IFRS 16.45 requires the lessee to remeasure the lease liability by discounting the revised lease payments using a revised discount rate determined at the effective date of the modification. The revised rate is the interest rate implicit in the lease if it can be readily determined, or otherwise the lessee's incremental borrowing rate at the modification date - not the original commencement-date rate. What you do with the remeasurement then splits into two mutually exclusive cases set out in IFRS 16.46.

IFRS 16.46(a) covers modifications that decrease the scope of the lease - a partial (or full) termination. IFRS 16.46(b) covers all other modifications - a price rise, a term extension, an added asset that failed the separate-lease test. The two cases are handled very differently: 16.46(a) can crystallise a gain or loss in profit or loss today, whereas 16.46(b) is a balance-sheet-only adjustment that flows entirely through the ROU asset. Confusing the two is the single most consequential judgement in this area.

Decrease in scope: partial termination (IFRS 16.46(a))

Where the modification decreases the scope, IFRS 16.46(a) requires the lessee to decrease the carrying amount of the ROU asset to reflect the partial or full termination of the lease, and to recognise in profit or loss any gain or loss relating to the partial or full termination. In practice this is a two-part mechanic: first reduce the ROU asset and liability to reflect the portion of the right of use given up, booking the difference to P&L; then remeasure the surviving liability for any change in the remaining payments using the revised discount rate under IFRS 16.45. The proportion given up is measured on a reasonable basis - commonly the change in the liability, or the change in floor area or remaining term.

Worked example 1: giving up a floor

A lessee occupies two identical floors under a lease with three years remaining. On 1 July 2026 it surrenders one floor; rent falls from £200k to £100k a year. Carrying amounts immediately before the modification are an ROU asset of £520,000 and a lease liability of £560,000. The lessee measures the decrease in scope by the reduction in the liability: giving up one of two floors reduces the remaining right of use by 50%.

The liability is derecognised by more than the ROU asset because it was carrying a higher balance, so the difference is a £20,000 gain. After derecognition the surviving liability (£280,000) is remeasured against the revised remaining payments at the revised discount rate per IFRS 16.45; any further change is added to, or deducted from, the ROU asset under IFRS 16.46(b), not taken to P&L. The termination journal is:

All other modifications: revised rate to the ROU asset (IFRS 16.46(b))

For every modification that is not a decrease in scope, IFRS 16.46(b) requires the lessee to make a corresponding adjustment to the carrying amount of the ROU asset for the remeasurement of the lease liability. The liability is remeasured under IFRS 16.45 using the revised discount rate, and the entire change - up or down - is absorbed into the ROU asset. No gain or loss arises. This is the branch for rent increases, term extensions, and added assets that fail the IFRS 16.44 commensurate-price test.

One edge case: if a scope-reducing element and a price change occur together, deal with the scope decrease first under 16.46(a), then apply 16.46(b) to the rest. And where a downward remeasurement under 16.46(b) exceeds the carrying amount of the ROU asset, the ROU asset is reduced to nil and any remaining amount is recognised in profit or loss - the only way 16.46(b) touches the income statement.

Worked example 2: term extension at a new rate

On 1 January 2026 a lessee has an office lease with four years and £300k annual rent remaining; the liability stands at £1,063,000 (discounted at the original 5% rate). The parties agree to extend the term by three years (to seven years remaining) and raise rent to £320k a year from the modification date. This increases scope-by-consideration but was not priced at a stand-alone rate, so it fails IFRS 16.44 and is a non-separate modification under IFRS 16.46(b). The lessee determines a revised incremental borrowing rate of 6% at the modification date (IFRS 16.45).

The whole £723,000 increase is added to the ROU asset - there is no day-one P&L effect (IFRS 16.46(b)). The revised liability then accretes interest at the revised 6% rate and the grossed-up ROU asset is depreciated over the revised seven-year term.

The rate rule in one line. Reassessment under IFRS 16.42 (index/rate) → unchanged discount rate. Modification under IFRS 16.45 → revised discount rate at the modification date. Getting this backwards is the error auditors see most, and it flows straight into the liability and the ROU asset.

What do auditors test on lease modifications?

Auditors treat lease modifications as an estimate with a classification overlay, so testing runs on two fronts: was the change put down the right branch of IFRS 16.44-46, and were the inputs - chiefly the revised discount rate - reasonable. The three red flags below each map to a specific ISA and each has caused restatements in practice.

Red flag 1: a scope-increase booked as part of the original lease

Under ISA 315 (Revised), the auditor identifies risks of material misstatement in how the entity classifies transactions. The prime risk here is a modification that adds a right of use being swept into the existing lease when IFRS 16.44 would make it a separate lease - or the reverse, a genuinely bundled add-on being carved out as a new lease to avoid remeasuring at a revised rate. Both distort the liability and the ROU asset. Auditors walk the IFRS 16.44 test explicitly: did scope increase, and was the added consideration commensurate with a stand-alone price? A missing stand-alone-price analysis is a control-design gap to flag.

Red flag 2: the revised discount rate is stale or unsupported

The revised discount rate is an accounting estimate, so ISA 540 (Revised) applies in full. The frequent failing is reusing the original commencement-date rate for a 16.45 remeasurement - which understates or overstates the liability - or pulling a revised IBR with no build-up (risk-free rate, credit spread, term and security adjustments) as at the modification date. Auditors challenge the point-in-time evidence for the rate, its sensitivity, and whether management applied a revised rate at all where IFRS 16.45 requires one. A one-percentage-point error on a multi-year liability is easily material.

Red flag 3: weak evidence and a mis-split P&L gain

Under ISA 500, the auditor obtains sufficient appropriate evidence over both the existence of the modification and the split between P&L and the ROU asset. Two things get tested: the signed modification agreement (does the contract actually support the revised payments and term?), and the IFRS 16.46(a) versus 16.46(b) split. A common overstatement is running a decrease in scope through the ROU asset only, suppressing a real termination gain or loss; a common error the other way is taking an ordinary 16.46(b) re-price to P&L. Auditors recompute the proportionate derecognition and vouch the gain to the underlying calculation.

Case study: a filed store-estate downsizing

Usman Qureshi (ACCA)

Lease modifications are one of the trickiest areas of IFRS 16. On audits I have seen companies miss modifications entirely, misfile them as reassessments, and - most costly - run a decrease in scope through the ROU asset so a real termination gain never surfaces. Classify against IFRS 16.44 first, then pick 16.46(a) or 16.46(b), then evidence the revised rate.

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