Summary: When a lease modification under Ind AS 116 results in a decrease in scope, such as a reduction in the leased area or a shortened term, the accounting requires a structured, multi-step remeasurement of both the Right-of-Use (ROU) Asset and the Lease Liability (LL). Initially, the carrying values of the ROU Asset and LL must be determined on the modification date based on the original discount rate and amortization schedule. The next step is to compute the values to be retained based on the proportionate decrease; for an area reduction, the retained ROU Asset and LL are proportional to the new area, while for a term reduction, the retained ROU Asset is proportional to the new term, and the retained LL is the present value of the original cash flows over the revised term. The difference between the original carrying value and the retained value of both the LL and ROU Asset is then reversed, with the adjustment routed through the Statement of Profit and Loss. Finally, the modified lease payments are discounted using a revised discount rate applicable on the modification date to determine the new LL. The difference between this new LL and the retained LL (from the previous step) is adjusted against the ROU Asset. The resulting modified ROU Asset and LL then become the new basis for future accounting, where interest and depreciation are calculated using the revised rate and remaining term.
Below is a structured and step by step approach to handle such cases:
Step 1: Calculate the Present Value (PV) of the Original Cash Outflows:-
Determine the PV of lease payments using the original discount rate as per the initial lease agreement.
Step 2:Prepare an Amortization Schedule
Create an amortization table for the original lease payments to determine the carrying value of the Lease Liability (LL) over time.
(Steps 1 and 2 represent the original accounting before any modification.)
Step 3:Determine the Carrying Value on the Date of Modification
Find the carrying value of both the Right-of-Use Asset (ROU) and Lease Liability (LL) as on the date of modification
If the Modification Involves a Decrease in Area:
Step 4:Compute Value to be Retained in Lease Liability:
Carrying Value of LL÷ Total Old Area× New Lease Area
Step 5:Compute Value to be Retained in ROU Asset:
Carrying Value of ROU Asset÷Total Old Area×New Lease Area
If the Modification Involves a Decrease in Lease Term:
Step 4:Compute Value to be Retained in Lease Liability:
Recalculate the Present Value of Original Cash Outflows using the original discount rate for the revised lease term.
Step 5:Compute Value to be Retained in ROU Asset:
Carrying Value of ROU Asset÷Total Old Lease Term×New Lease Term
Step 6:Adjust for the Decrease in Lease Liability
The difference between the carrying value of LL (Step 3) and the value computed in Step 4 should be reversed.
Step 7:Adjust for the Decrease in ROU Asset
The difference between the carrying value of the ROU asset (Step 3) and the value computed in Step 5 should be reversed.
Journal Entry
Lease Liability A/c Dr.
To Right-of-Use Asset A/c
(Difference routed through Statement of Profit and Loss)(Vice-Versa)
Step 8:Compute the PV of Modified Cash Outflows
Recalculate the present value of revised lease payments using the modified discount rate applicable at the modification date.
Step 9:Find the Difference Between Step 8 and Step 4
Compare the revised PV of lease payments (Step 8) with the retained LL value (Step 4).
Step 10:Adjust the Difference Through the ROU Asset
If Modified Lease Liability Decreases:
Lease Liability A/c Dr.
To Right-of-Use Asset A/c
If Modified Lease Liability Increases:
Right-of-Use Asset A/c Dr.
To Lease Liability A/c
Step 11: Post-Modification Accounting
After all the above adjustments are made, the modified lease liability (LL) and the revised Right-of-Use (ROU) asset become the new bases for subsequent accounting.
From the modification date onward, normal accounting resumes as follows:
- Interest Expense will be recognized on the modified lease liability using the revised discount rate determined at the modification date.
- Depreciation Expense will be charged on the revised ROU asset over the remaining lease term after modification.
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