Warehouse lease: extension option and remeasurement under IFRS 16
On 1 January 20X1, Mirae Logistics leases a warehouse for a fixed term of five years, with fixed annual payments of ₩120 million payable in arrears on 31 December. The lease includes an option to extend for three years at ₩140 million per year. Mirae installs specialized racking that would cost ₩80 million to dismantle and relocate; because of this, it concludes at inception that it is reasonably certain to exercise the extension option. Mirae pays ₩10 million of initial direct costs and receives a ₩30 million lease incentive from the lessor. The contract also requires variable payments equal to 2% of annual warehouse sales above ₩500 million; 20X1 sales are ₩700 million. Mirae's incremental borrowing rate is 6%. At 31 December 20X2, Mirae changes its distribution strategy and no longer expects to use the warehouse after the initial five-year term; the extension option is no longer reasonably certain. The remaining non-cancellable term is three years, and the relevant discount rate remains 6%.
1. Calculate the initial lease liability and right-of-use asset at 1 January 20X1. Show the treatment of the extension option, initial direct costs, incentive, and variable payments.
Read the worked answer
The lease term is eight years because Mirae is reasonably certain to exercise the extension. Fixed payments are ₩120m for years 1–5 and ₩140m for years 6–8, all in arrears. Discount at 6%:
- PV of ₩120m for five years = 120 × 4.21236 = ₩505.48m.
- PV of ₩140m for years 6–8 = 140 × 2.67301 × 0.74726 = ₩279.64m.
- Initial lease liability = ₩505.48m + ₩279.64m = ₩785.12m.
The right-of-use asset is the lease liability plus initial direct costs less the lease incentive: ₩785.12m + ₩10m − ₩30m = ₩765.12m. Variable payments are not included in the lease liability because they are not fixed or in-substance fixed. The 20X1 variable payment is 2% × (₩700m − ₩500m) = ₩4m and is expensed in profit or loss.
2. Calculate the remeasurement at 31 December 20X2 and explain the accounting effect.
Read the worked answer
At 31 December 20X2, reassess the lease term. Because the extension is no longer reasonably certain, the remaining term is three years. The liability before remeasurement is:
- End 20X1: ₩785.12m × 1.06 − ₩120m = ₩712.23m.
- End 20X2: ₩712.23m × 1.06 − ₩120m = ₩634.96m.
Revised liability = PV of three ₩120m payments in arrears at 6% = 120 × 2.67301 = ₩320.76m. Reduce the lease liability by ₩314.20m and adjust the right-of-use asset by the same amount. The ROU asset before adjustment is ₩765.12m − 2 × (₩765.12m/8) = ₩573.84m, so it becomes ₩259.64m. There is no immediate profit or loss because the ROU asset is sufficient to absorb the adjustment. Future depreciation is revised over the remaining three-year term.
3. How would the initial measurement differ if Mirae had not been reasonably certain at inception to exercise the extension option?
Read the worked answer
If the extension were not reasonably certain, the lease term would be five years. The initial lease liability would be the PV of five ₩120m payments in arrears at 6% = ₩505.48m. The ROU asset would be ₩505.48m + ₩10m − ₩30m = ₩485.48m. The ₩140m extension payments would be excluded until a significant event or change in circumstances requires reassessment. This illustrates that the lease term is a judgement based on whether the lessee is reasonably certain to exercise an option, not merely whether it has the contractual right.