What happens in the accounts when an IFRS 16 lease is terminated early?
When leases accounted for under IFRS 16 are terminated early, questions often arise regarding the treatment of the right-of-use asset, the lease liability, and the income statement. As depreciation of the asset and amortisation of the liability rarely result in identical carrying amounts, an early termination typically gives rise to a difference that impacts equity and profit or loss. This article explains how such terminations are accounted for and why the outcome is often positive.
When a lease is terminated early, it represents a deviation from the way the contract was originally recognised. In practice, the lease is simply “cut off” as of the termination date.
Up to that point, depreciation has been recognised on the asset and amortisation on the liability, but the two amounts are rarely identical. As a result, at the time of termination there is a remaining lease liability and a remaining asset, and the difference between them affects equity.
How an early termination is accounted for under IFRS 16
– What needs to be done is to derecognise the lease, with the lease liability representing the best indication of fair value. Both the lease liability and the right-of-use asset are derecognised. The difference between them, that is the impact on equity, is recognised in profit or loss as other operating income. This means that the entire difference between the asset and the liability is accounted for through the income statement, explains IFRS 16 expert Richard Nilsson.
He continues:
– Note that it is common for a slightly larger portion of the asset to have been depreciated compared to the amount amortised on the liability. This results in a positive effect, as a greater portion of the cost has already been recognised.