Lease term, as defined at Appendix A of AASB 16 Leases (AASB 16), is the non-cancellable period for which a lessee has the right to use an underlying asset, together with the periods covered by an option to:
- extend the lease, if the lessee is reasonably certain to exercise that option
- terminate the lease, if the lessee is reasonably certain not to exercise that option.
AASB 16 extract:
In determining whether a lease is enforceable, penalties for termination of the contract may be broader than just contractual penalties and may also encompass economic costs or other impacts. These may include:
- the importance of the underlying asset to the lessee’s business
- the lessee’s relocation costs, including the carrying value of the lessee’s leasehold improvements abandoned on termination and make good obligations incurred
- whether the lessor could lease out the asset to other lessees on similar terms.
Where lease agreements are open ended and have no or nominal termination penalties for both lessee and lessor, including economic costs on termination, the lease is effectively cancellable. The lease term would therefore not extend beyond the contractual notice period required. This would often be the case for Memorandum of Understanding (MOU) lease arrangements between Commonwealth entities.
In some cases, lease agreements may be open ended and have no or nominal contractual termination penalties for both lessee and lessor, but both lessee and lessor would incur significant economic penalties if the lease was terminated. In these cases, the lease may in substance be considered non-cancellable beyond the contractual notice period. The lease term would extend for the estimated period for which significant economic costs would still be incurred by both lessee and lessor on termination. The useful life of leasehold improvements may also extend beyond the contractual period of notice required under the lease.
For options to either extend or terminate the lease, indicators of reasonable certainty include:
- a clear ongoing operational requirement for the underlying asset’s capability
- a lack of suitable alternative assets at similar price
- significant costs for alternative arrangements (eg. relocation or integration costs)
- significant leasehold improvements undertaken over the term of the lease
- a precedent from previous practice.
AASB 16 extract:
Paragraph 40: A lessee shall remeasure the lease liability by discounting the revised lease payments using a revised discount rate, if either:
- there is a change in the lease term, as described in paragraphs 20–21. A lessee shall determine the revised lease payments on the basis of the revised lease term; or
- there is a change in the assessment of an option to purchase the underlying asset, assessed considering the events and circumstances described in paragraphs 20–21 in the context of a purchase option. A lessee shall determine the revised lease payments to reflect the change in amounts payable under the purchase option.
After the commencement date, a lessee should re-assess the lease term following a significant event or change in circumstances within their control, which affects whether the lessee is reasonably certain to exercise an option to extend, or not to exercise an option to terminate. Re-measurement of lease liabilities from re-assessment of lease terms should use a revised discount rate.
Paragraphs 18 to 21 of AASB 16 detail requirements for determining lease terms with application guidance provided at paragraphs B34 to B41 of AASB 16.
Note 6: Lease terms
Where lease agreements are open ended and have no or nominal termination penalties for both lessee and lessor, including economic costs on termination, the lease is effectively cancellable and the lease term would therefore not extend beyond the contractual notice period.
In some cases, lease agreements may be open ended and have no or nominal contractual termination penalties for both lessee and lessor, but both lessee and lessor would incur significant economic penalties if the lease was terminated. These leases may in substance be considered non-cancellable and the lease term may extend beyond the contractual notice period.
