Accounting for Lease Terminations and Partial Terminations under IFRS 16

Introduction

Lease terminations occur when a lease is ended before its originally agreed expiry date. These transactions are common in practice, particularly when entities restructure operations, downsize premises, dispose of business units, or renegotiate unfavourable lease terms. Under IFRS 16 Leases, lease terminations require the derecognition of existing lease balances and recognition of any resulting gain or loss.

Partial lease terminations add an additional layer of complexity. Instead of cancelling the entire lease, only part of the right-of-use is surrendered. This requires a proportionate adjustment to both the lease liability and the right-of-use asset, together with a recalculation of future depreciation and interest expense.

This article forms part of our full IFRS 16 guide.

What is a lease termination?

A lease termination arises when the enforceable rights and obligations relating to the use of an underlying asset cease before the end of the lease term. This may occur through:

• A mutual agreement between the lessee and lessor
• The exercise of a contractual termination option
• The payment of a termination penalty
• A legal or commercial event that renders the lease unenforceable

From an accounting perspective, a termination represents the removal of a previously recognised right-of-use asset and lease liability from the statement of financial position.

Common causes of lease terminations

Lease terminations often arise from commercial and operational decisions rather than accounting considerations. Typical examples include:

• Business downsizing or closure of operations
• Relocation to new premises
• Renegotiation of lease terms in weak property markets
• Subletting or surrendering excess space
• Disposal of leased assets that are no longer required

These events frequently result in non-routine accounting entries and therefore require careful attention.

Accounting framework under IFRS 16

IFRS 16 treats a lease termination as a form of lease modification. The accounting depends on whether:

• The termination reduces the scope of the lease, and
• The consideration for the lease is changed

For a lessee:

• A full termination results in complete derecognition of the lease balances.
• A partial termination results in proportional derecognition of the lease balances.

In both cases, any difference between the adjusted carrying amounts and payments made or received is recognised in profit or loss.

Full lease termination – lessee accounting

When a lease is fully terminated, the lessee must:

1. Derecognise the lease liability.
2. Derecognise the right-of-use asset.
3. Recognise any termination payments made to the lessor.
4. Recognise any gain or loss in profit or loss.

The gain or loss is calculated as:

Gain or loss = Carrying amount of ROU asset
– Carrying amount of lease liability
– Termination payments (if any)

If the lease liability exceeds the right-of-use asset and termination costs are minimal, a gain may arise. Conversely, if the right-of-use asset is higher or a significant penalty is paid, a loss will be recognised.

This treatment reflects the fact that the lessee no longer controls the use of the underlying asset and therefore no longer has an economic resource to recognise.

Partial lease termination – lessee accounting

A partial termination occurs when only part of the lease is cancelled. Common examples include:

• Giving up a portion of leased office space
• Returning some of the leased equipment in a multi-asset contract
• Reducing production capacity under a long-term lease

In this case, the lessee must:

1. Reduce the lease liability to reflect the revised future lease payments.
2. Reduce the right-of-use asset in proportion to the reduction in scope.
3. Recognise any difference between the two as a gain or loss in profit or loss.

The reduction in the right-of-use asset is based on the proportion of the right of use that is terminated. For example:

• A 20% reduction in floor space typically results in a 20% reduction in the carrying amount of the right-of-use asset.

After the partial termination:

• The remaining right-of-use asset is depreciated over the revised lease term.
• The remaining lease liability is accreted using the revised effective interest calculation.

Partial terminations require strong judgement and robust documentation, particularly where the reduction in scope is not easily quantifiable. Companies often use the reduction in lease payments as a indication of the reduction in scope. In other words, a 20% reduction in the lease liability, is also treated as a 20% reduction in the right-of-use asset.

Lease modifications versus terminations

All lease terminations are lease modifications, but not all lease modifications are terminations.

Correctly identifying whether a change is a termination or a modification is critical, as the accounting outcomes differ materially.

Lessor accounting considerations

For lessors, the accounting treatment depends on the classification of the lease:

• Operating lease
  • The underlying asset remains recognised.
  • Lease income ceases from the termination date.
  • Any compensation received is recognised in profit or loss.

• Finance lease
  • The net investment in the lease is adjusted or derecognised.
  • A portion of the underlying asset (previously derecognised) may now qualify for recognition.
  • Gains or losses may arise depending on settlement amounts.

Unlike lessee accounting, lessor accounting does not involve a right-of-use asset but focuses on the net investment in the lease or the underlying asset itself.

Practical challenges and judgement areas

Lease terminations are often high-risk accounting areas due to:

• Complexity of calculations
• Non-standard contractual terms
• Material one-off impacts on profit or loss
• Judgement in determining proportional reductions
• Risk of misclassification between termination and modification

Strong internal controls and documentation are essential to support the accounting treatment.

Disclosure considerations

Entities should disclose:

• Significant judgements made in accounting for terminations
• The financial impact of lease terminations on profit or loss
• Material changes to lease liabilities and right-of-use assets
• Any unusual or non-recurring lease-related transactions

Transparent disclosures help users of financial statements understand volatility and changes in lease exposure.

Conclusion

Lease terminations, whether full or partial, represent significant events under IFRS 16 and require careful accounting to ensure that lease balances are correctly derecognised and gains or losses are appropriately recognised. Partial terminations are particularly complex due to the need for proportional adjustments and revised depreciation profiles.

For clarification, guidance, or feedback, reach out at insight@leash.co.za.