Insights into IFRS 16 Lease Term - Factors to Consider

Oct 22, 2026

Determining the correct lease term under IFRS 16 is critical because it directly affects the size of the lessee’s right-of-use asset and lease liability, influences eligibility for the short-term lease exemption, and requires careful use of application guidance for periods covered by extension or termination options. The lease term includes non-cancellable periods and qualifying optional periods based on “reasonably certain” criteria. The analysis also covers enforceability, the distinction between commencement and inception dates, initial assessment timing, and examples of economic incentives.

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Pages7

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Lease term and its significance

“Reasonably certain” and how lease term is defined

Enforceability and contract assessment

When a lease is no longer enforceable

Initial assessment at lease commencement date

Relevant facts and circumstances

Examples of economic incentives

Contractual terms vs market rates

Leasehold improvements, termination costs, and asset importance

Option conditions and interaction with other contractual features

Tax Insights into IFRS 16 Lease term Under IFRS 16 ‘Leases’, determining the correct lease term is significant for a number of reasons. Firstly, the longer the lease term, the larger the lessee’s right-of-use asset and lease liability will be. Secondly, the length of the lease term determines whether a lease qualifies for the short-term lease exemption. Finally, IFRS 16 contains additional application guidance on how to deal with periods covered by options to extend or terminate a lease. While this detailed guidance can be helpful, determining the lease term is not an easy task to undertake and we set out below what factors should be taken into consideration. In our view, ascertaining the correct lease term is one of the most challenging issues in properly applying IFRS 16 because it does require a significant level of judgement. ‘Lease term’ is defined as the non-cancellable period for which a lessee has the right to use an underlying asset (including any periods covered by a lessor’s termination option), plus: • periods covered by a lessee’s extension option if extension is reasonably certain, and • periods covered by a lessee’s termination option if the lessee is reasonably certain not to terminate. While the concept of ‘reasonably certain’ did not change Purchase options need to be assessed in the same way as options to extend or terminate a lease. The International Accounting Standards Board (IASB) believes that a purchase option is economically similar to an option to extend the lease term for the remaining economic life of the underlying asset. Enforceability IFRS 16 defines a contract as an agreement between two or more parties that creates enforceable rights and obligations. In determining the lease term and assessing the length of thenon-cancellable period of a lease, an entity needs to apply the definition of a contract and determine the period for which the contract is enforceable. A lease is no longer enforceable when both the lessee and the lessor each have the right to terminate the lease without permission from the other party with no more than an insignificant penalty. when IFRS 16 was implemented, this is considered a fairly high hurdle and the application of this concept in practice requires consideration of all the facts and circumstances that create a significant economic incentive for a lessee to extend the lease (where a lessee has an extension option) or not to terminate a lease (where the lessee has a termination option). This is ultimately a judgement call that needs to take into consideration facts and circumstances specific to the asset being leased, the entity and the wider market. As these factors are wide ranging, we expect this will always be a challenging area in practice. Initial assessment of the lease term Entities are required to assess a lease’s term at the lease‘commencement date’ which is the date on which a lessor makes an underlying asset available for use by a lessee. It is important to contrast the lease commencement date with the lease ‘inception date’, which is the earlier of the date of a lease agreement and the date of commitment by both parties to the terms and conditions of the lease. A lease term begins atthe commencement date and includes any rent-free periods provided to the lessee by the lessor. When assessing whether a lessee is reasonably certain to exercise an option to extend the lease or to purchase the underlying asset, or not exercise an option to terminate the lease, the lessee considers all relevant facts and circumstances (both monetary and non-monetary) that create an economic incentive for the lessee to exercise or not exercise that option. It should include any expected changes in facts and circumstances from the commencement date until the exercise date of the option. Examples offacts and circumstances that may create an economic incentive to exercise or not exercise an option | Contractual terms and conditions compared with

FAQs

Why does determining the lease term matter under IFRS 16?

It affects the size of the lessee’s right-of-use asset and lease liability, determines whether short-term lease exemption applies, and guides how to handle periods covered by options to extend or terminate.

How is “lease term” defined under IFRS 16?

It is the non-cancellable period plus periods covered by a lessee extension option when extension is reasonably certain, and periods covered by a lessee termination option when the lessee is reasonably certain not to terminate.

What is the role of enforceability when assessing lease term?

A contract creates enforceable rights and obligations, and the lease is no longer enforceable when both parties can terminate without permission and without more than an insignificant penalty.

Oct 22, 2026

Uploaded by Lucas Martin