Ending a lease early – how does it work?

Leasing agreements are usually binding, often lasting two to five years. But what if you need to terminate a lease early? How should this be accounted for correctly under IFRS 16? To provide clarity, we’ve turned to IFRS 16 expert Richard Nilsson for his insights.

When and Why Are Leases Terminated Early?
As mentioned earlier, leasing agreements typically span two to five years. However, situations may arise that necessitate the early termination of a lease. This can occur for various reasons, such as shifting business needs, financial circumstances, or other unforeseen events. For instance, if an employee with a company car leaves their position, the car's lease may need to be terminated. While early terminations are more common with vehicle leases, the same accounting principles apply to other types of leasing and rental agreements as well.

What Happens When a Lease is Terminated Early?
When a lease agreement is terminated early, it’s crucial to understand how both the liability and the asset are handled in the accounting process. In leases typically amortized using the annuity method, the liability decreases differently than the asset, which decreases through straight-line depreciation.

– In the case of an early termination, there is often a situation where the liability exceeds the asset. This occurs because the amortization payments are initially lower than the depreciation, as the interest portion of the lease payments is higher early on due to the larger liability. Over time, this difference diminishes and reverses at the midpoint of the lease, with amortization exceeding depreciation, explains Richard Nilsson.

The difference between depreciation and amortization creates the temporary result in a lease. When a lease is interrupted mid-term, the liability is typically higher than the asset, and this difference forms the resulting adjustment. In such cases, the liability becomes the guideline, requiring the entire result difference to be corrected. This adjustment is often reported as "other operating income" in the income statement and essentially serves as a correction of previous depreciation.

Richard further elaborates on how disposals are handled for both the asset and liability:

– On the asset side, the acquisition value will be entirely written off. For example, if the acquisition value is SEK 100,000, the full amount will be disposed of. If the lease is terminated after SEK 80,000 in depreciation, that amount will also be disposed of, meaning all previous acquisition values and depreciation are cleared.

– On the liability side, the remaining liability is also written off. The difference between the asset and liability is then adjusted through the income statement as other operating income, effectively neutralizing the temporary result.

Simplify the Management of Early Lease Terminations
Terminating a lease early can be challenging, but with Leasify, the process becomes significantly easier. Leasify provides a SaaS solution that ensures accurate and efficient handling of leasing and rental agreements from start to finish. When a lease is terminated early, Leasify’s service handles the necessary calculations and systematically manages the disposal of both the asset and the liability—all it takes is selecting the month and clicking save. By automating these steps, Leasify ensures that your accounting is not only accurate but also fully compliant with IFRS 16 standards and auditor requirements.