Lease Modifications Under IFRS 16: Remeasurement and Accounting Entries in the UAE

What happens when a UAE business changes the terms of an existing lease? 

Under IFRS 16 lease modification requirements, changes such as rent revisions, lease extensions, additional space, or early termination can require the lease liability and right-of-use (ROU) asset to be remeasured. The accounting depends on the nature of the modification and whether it qualifies as a separate lease. For UAE businesses, applying the correct treatment helps maintain reliable financial statements and supports accurate Corporate Tax reporting.

So, when should a lease be measured, which discount rate should be used, and what journal entries are required? Let’s break it down step by step.

What Is a Lease Modification Under IFRS 16?

A lease modification occurs when the original contractual terms and conditions of a lease are changed. Common examples include:

• Adding or removing leased office space
• Extending or shortening the lease period
• Increasing or decreasing rental payments
• Changing the scope of a lease
• Adding another property or asset to an existing arrangement
• Terminating part or all of a lease
• Changing contractual terms relating to the use of an underlying asset

For a UAE business, an office lease could initially cover 2,000 square feet for five years. Two years later, the company may negotiate an additional 1,000 square feet or decide to surrender part of the premises. Such changes can trigger the IFRS 16 lease modification requirements.

The key accounting question is whether the modification should be treated as a separate lease or whether the existing lease must be remeasured.

When Is a Lease Modification a Separate Lease?

Under IFRS 16, a lessee accounts for a modification as a separate lease when both of the following conditions are met:

1. The modification increases the scope of the lease by adding the right to use one or more underlying assets.
2. The additional consideration is commensurate with the stand-alone price for the increase in scope, adjusted where appropriate for the circumstances of the contract. 

Example: Additional Office Space

A Dubai company leases 1,000 square metres of office space. Later, it agrees with the landlord to add another 300 square metres. The additional rent reflects the stand-alone market price for that additional space.

If the IFRS 16 conditions are satisfied, the additional space may be accounted for as a separate lease.

In this situation, the existing lease is not remeasured for the modification. Instead, the additional lease is accounted for separately.

When Is a Lease Modification Not a Separate Lease?

If the modification does not meet both conditions for separate-lease treatment, the lessee accounts for it as a modification of the existing lease.

At the effective date of the modification, IFRS 16 requires the lessee to:

• Reallocate consideration where necessary
• Determine the modified lease term
• Remeasure the lease liability
• Apply the appropriate revised discount rate
• Adjust the ROU asset accordingly

This is where IFRS 16 remeasurement becomes particularly important.

How Does IFRS 16 Remeasurement Work?

For a non-separate lease modification, the lessee generally remeasures the lease liability by discounting the revised lease payments using a revised discount rate. The revised discount rate is generally:

• The interest rate implicit in the lease for the remainder of the lease term, if that rate can readily be determined; or
• The lessee’s incremental borrowing rate at the modification date, if the implicit rate cannot readily be determined. 

This means a UAE company should not automatically continue using the original discount rate when a modification requires remeasurement.

Simple Remeasurement Example

Assume a UAE company has a lease with:

• Existing lease liability: AED 500,000
• Remaining lease term: 3 years
• Revised annual lease payments: AED 190,000
• Revised discount rate: 6%

The company calculates the present value of the revised lease payments using the applicable revised discount rate.

Assume the resulting revised lease liability is AED 507,500.

The increase is:

AED 507,500 − AED 500,000 = AED 7,500

The company would generally increase the lease liability by AED 7,500 and make a corresponding increase to the ROU asset, assuming this is a modification other than one that decreases the scope of the lease.

Journal Entry for an Increase in Lease Liability

A simplified entry would be:

Account	Debit (AED)	Credit (AED)
Right-of-use asset	7,500	—
Lease liability	—	7,500

This increases both the ROU asset and lease liability.

The exact calculation should be based on the revised contractual cash flows and the applicable discount rate rather than simply recording the difference between total future payments.

What Happens When the Lease Scope Decreases?

A different treatment applies when a modification reduces the scope of the lease. For example, a UAE company may lease 5,000 square feet of office space but later agree to surrender 2,000 square feet before the original lease ends.

IFRS 16 requires the lessee to reduce the carrying amount of the ROU asset to reflect the partial or full termination. Any resulting gain or loss from the partial or full termination is recognised in profit or loss.

Example: Partial Lease Termination

Assume:

• Original ROU asset carrying amount: AED 600,000
• Lease liability: AED 580,000
• 40% of the leased space is surrendered
• 40% of the relevant ROU asset is therefore AED 240,000
• Related portion of lease liability: AED 232,000

The company removes the relevant portions:

ROU asset reduction: AED 240,000
Lease liability reduction: AED 232,000

The difference creates a gain of:

AED 240,000 − AED 232,000 = AED 8,000

A simplified entry could be:

Account	Debit (AED)	Credit (AED)
Lease liability	232,000	—
Gain on lease modification	—	8,000
Right-of-use asset	—	224,000

The actual entry will depend on the precise carrying amounts and allocation methodology.

Accounting for Other Lease Modifications

For modifications that do not decrease the scope of the lease, IFRS 16 generally requires a corresponding adjustment to the ROU asset for the remeasurement of the lease liability. 

For example, suppose a UAE company negotiates a longer lease term without adding a separate underlying asset.

If the revised lease payments result in a higher present value, the company would generally:

• Debit: Right-of-use asset
  Credit: Lease liability

If the revised measurement reduces the liability, the ROU asset is generally reduced, subject to the specific IFRS 16 requirements.

Common Types of Lease Modifications in the UAE

1. Lease Extension

• A company may extend an office, warehouse or retail lease beyond the original contractual period.
• The extension can change the lease term and therefore affect the measurement of the lease liability.
• The company should reassess the revised lease payments and determine the appropriate discount rate where IFRS 16 requires remeasurement.

2. Rent Increase

• A landlord and tenant may agree to increase rent during the existing lease.
• The accounting depends on why the payments changed and the contractual terms.
• Not every change in lease payments is necessarily accounted for in exactly the same way as a negotiated lease modification. Changes resulting from an index or rate, for example, are addressed separately under IFRS 16’s reassessment requirements. 

3. Reduction in Leased Space

• A company may reduce the size of an office, warehouse or retail location.
• This can represent a decrease in lease scope and may require:
  • Reduction of the lease liability
  • Reduction of the ROU asset
  • Recognition of any resulting gain or loss

4. Early Termination

• A company may terminate a lease before its original expiry date.
• If this reduces the scope of the lease, the relevant portion of the lease liability and ROU asset is derecognised, with any resulting difference recognised in profit or loss as required by IFRS 16. 

5. Adding Additional Assets

• A business may add another property, vehicle or piece of equipment to an existing arrangement.
• If the additional right of use and consideration meet the criteria in IFRS 16 paragraph 44, the modification can qualify as a separate lease. 

IFRS 16 Lease Modification: Step-by-Step Process

UAE accountants can use the following process when reviewing a modification.

Step 1: Review the Original Lease

Obtain the original lease agreement and identify:

• Original lease term
• Lease payments
• Discount rate
• ROU asset
• Lease liability
• Payment schedule
• Options and termination provisions

Step 2: Identify What Changed

Determine whether the modification involves:

• Additional space
• Reduced space
• Revised rent
• Extension
• Reduction in lease term
• Early termination
• Another change in contractual rights or obligations

Step 3: Determine Whether It Is a Separate Lease

Check whether the modification:

• Adds a right to use one or more underlying assets; and
• Increases consideration by an amount commensurate with the applicable stand-alone price.

If both conditions are satisfied, separate-lease accounting may apply. 

Step 4: Calculate the Revised Lease Payments

Determine the lease payments applicable to the modified arrangement and the remaining lease term.

Step 5: Determine the Appropriate Discount Rate

For a non-separate modification requiring remeasurement, determine the revised discount rate in accordance with IFRS 16.

Step 6: Remeasure the Lease Liability

Calculate the present value of the revised lease payments.

Step 7: Adjust the ROU Asset

Adjust the ROU asset for the corresponding change in the lease liability, subject to the specific requirements for decreases in scope.

Step 8: Record the Journal Entry

Record the required adjustment and maintain documentation supporting the calculation.

Documentation UAE Businesses Should Keep

A strong audit trail is particularly important when lease modifications involve significant amounts. Businesses should retain:

• Original lease agreement
• Modification agreement
• Correspondence with the landlord
• Revised payment schedule
• Lease commencement information
• Original lease liability calculation
• Revised lease liability calculation
• Discount-rate documentation
• ROU asset reconciliation
• Termination or extension documentation
• Journal entries
• Management’s accounting assessment
• Supporting calculations

The FTA accounting standards guide states that accounting standards govern how particular transactions and events are reported and directs taxpayers to the relevant standard setter for transaction-specific accounting requirements.

Maintaining this documentation helps the finance team explain the accounting treatment to auditors and support the figures reported in the financial statements.

Common IFRS 16 Lease Modification Mistakes

• Using the Original Discount Rate Automatically: A non-separate lease modification requiring remeasurement may require a revised discount rate. Simply carrying forward the original rate can result in an incorrect lease liability.
• Treating Every Modification as a New Lease: Not every modification creates a separate lease. The conditions in IFRS 16 paragraph 44 must be assessed first.
• Ignoring Partial Termination: Reducing leased space can create a decrease in lease scope. The corresponding reduction in the ROU asset and lease liability needs to be appropriately accounted for.
• Recording Only the Change in Cash Payments: The accounting adjustment is based on the remeasured present value of revised lease payments, not simply the difference between old and new total cash payments.
• Failing to Update the Lease Register: A modification should be reflected in the company’s lease records, payment schedule, ROU asset and lease liability calculations.
• Applying the Same Treatment to Every Lease: A company may have office leases, warehouses, vehicles and equipment with different contractual terms. Each modification should be assessed based on its specific facts and circumstances.

How Ripple Accountant Can Help UAE Businesses

Lease modifications can become difficult when a business manages multiple properties, branches, warehouses, vehicles or equipment leases. Identifying the correct treatment, calculating the revised lease liability and recording the corresponding ROU adjustment requires careful accounting review.

Ripple Accounting can support UAE businesses with accounting and bookkeeping, financial reporting, Corporate Tax support, audit support, and related compliance requirements. Ripple’s UAE-focused team helps businesses maintain organized accounting records and reliable financial reporting.

Contact Ripple to review the accounting treatment and help ensure the relevant records and calculations are properly maintained.

• Email: info@uaetaxcompliance.ae 
• Phone: +971 52 356 5409
• WhatsApp: +971 4 250 0833

Frequently Asked Questions

1. What is a lease modification under IFRS 16?

A lease modification is a change to the scope or consideration of a lease that was not part of the original terms and conditions. Examples include adding or removing leased space, extending the lease or changing contractual payments.

2. When is a lease modification treated as a separate lease?

A modification is treated as a separate lease when it adds the right to use one or more underlying assets and the additional consideration is commensurate with the stand-alone price for the increase in scope, including appropriate adjustments where applicable. 

3. Does every lease modification require remeasurement?

No. A modification that qualifies as a separate lease is accounted for separately. Other modifications may require remeasurement of the lease liability and an adjustment to the ROU asset.

4. Which discount rate is used for lease modification remeasurement?

For a non-separate modification requiring remeasurement, IFRS 16 generally requires a revised discount rate based on the interest rate implicit in the lease for the remainder of the lease term, if readily determinable, or the incremental borrowing rate at the modification date when the implicit rate cannot readily be determined. 

5. What happens when a lease modification reduces the leased area?

A decrease in lease scope generally requires the lessee to reduce the ROU asset and lease liability for the terminated portion and recognise any resulting gain or loss in profit or loss. 

6. Is IFRS 16 relevant to UAE Corporate Tax?

Yes, accounting standards are relevant to the preparation of financial statements used in the UAE Corporate Tax framework. UAE Ministerial Decision No. 114 of 2023 specifies the applicable accounting standards and methods for Corporate Tax purposes.

Conclusion

IFRS 16 lease modification accounting requires UAE businesses to look beyond the simple change in rent or lease terms. Changes such as lease extensions, additional premises, rent revisions, reductions in leased space and early termination can have different accounting consequences. Maintaining an updated lease register, recalculating the liability correctly and documenting the judgement behind the accounting treatment can help UAE businesses produce accurate financial statements and maintain appropriate Corporate Tax records.

Disclaimer: This article is provided for general educational and informational purposes only and does not constitute accounting, tax, audit, legal or financial advice. IFRS 16 treatment depends on the specific contractual terms, facts and circumstances of each lease. UAE businesses should consult a qualified accountant, auditor or tax professional before applying a lease-modification treatment to their financial statements or Corporate Tax calculations. Businesses should also verify the latest UAE legislation, FTA guidance, Ministry of Finance decisions and applicable IFRS requirements before making compliance decisions.