15.8 Reduction in scope - modification versus reassessment

A rental contract for 10 years with quarterly prepaid rent of € 25,000 paid in the beginning of each quarter. There’s no right to terminate the lease according to the original contract terms. The underlying asset is available on January 1st 2020. The discount rate is set at 5%. On January 1st 2025, the lessee and the lessor amend the contract to allow the lessee to reduce the rental period and end the contract on December 31st 2016, by paying a one-time payment € 120,000 on 1 January 1st 2025. The discount rate is considered to be 9% from 01.01.2025 for the remaining lease period. This amendment is not part of the original contract and should therefore be accounted for as a lease modification.

In this example, there are two elements to account for:

1. A reduction in the right of use asset and lease liability for partial termination of the lease (The lease period is reduced by three of the remaining five years, i.e. a 60% reduction in the lease period and nominal lease payments, which gives a corresponding reduction in the asset and a slightly smaller percentage reduction in the present value of the debt, because it’s the last periods that disappear).
2. A reduction in the remaining rental payments and termination consideration.

The original lease before modification is entered as a new lease in Share Control. The calculation result is shown below:

The remaining liability on January 1st 2025 before the modification is 446,395, of which 191,716 relates to the new remaining lease period of eight quarters, calculated with the original 5% discount rate. The new remaining liability for the modified lease payments (120,000 plus eight quarterly payments of 25,000) calculated by the new discount rate (9%) is 305,700. The liability for the remaining two years is therefore increased by 113,983 (305,700-191,716). The right of use asset is reduced by 60%, i.e. 238,847 (398,078 x 0.6), and the right of use asset is then adjusted correspondingly to the increase in liability (113,983). New calculations of liability, ROU asset and profit or loss effect are illustrated in the following table:

Open the original lease and click Log change. This modification can be registered as follows in Share Control Share Point add-in by using Log other changes.

The calculation will look as illustrated below:

The new value of ROU asset on 01.01.2025 is now 273,215 (=11,384+261,831). The gain on modification is 15,831. Click the number “-140,695” in the Change column. This enables you to find the new value of liability (305,700) on the effective date of the modification January 1st 2025.

If the original lease had contained a termination option at the end of year 2024 towards paying a one-time payment of 120,000 on January 1st 2025, this would not be a modification but a reassessment. There would have been only one element to account for, i.e. reduction in the right of use asset and lease liability for change in the assessment of the termination clause. The new value of the lease liability on January 1st 2025 would be same to the modification above (305,700). However, there would be no gains or losses to be recognized in the income statement, and the right of use asset would be adjusted according to the change of the lease liability.

Open the original lease and click Log change. This way, the reassessment can be registered as follows in Share Control Share Point add-in by using Log other changes.

The calculation will look as shown below:

The new value of ROU asset on January 1st 2025 is now 257,383 (=10,724+246,659). Click on the number “-140,695” in the Change column to locate the new value of liability (305,700) on the effective date of the modification (January 1st 2025).