Worked Example
Partial Termination Under ASC 842 and IFRS 16: A Worked Example
Bruce Conway
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The question this page answers
When a lessee gives back part of the leased asset mid-term, ASC 842 and IFRS 16 both require the right-of-use asset to be reduced proportionately. Neither standard prescribes what the proportion is measured against. Two bases are used in practice, both are accepted, and they do not produce the same answer - the difference lands in P&L on the day of the modification.
This page works the whole entry through on one fact pattern, both methods side by side, with the tie-outs that prove it.
Fact pattern
Lease terms at commencement | Value |
|---|---|
Commencement | 1 January 2025 |
Term | 36 months |
Fixed rent, payable monthly in advance | $10,000.00 |
Rent-free period | Months 1-2 |
Discount rate (annual / monthly) | 6.00% / 0.50% |
Initial direct costs | $5,000.00 |
Lease incentive received | $12,000.00 |
Initial measurement | Amount |
|---|---|
Present value of lease payments | $310,403.46 |
Plus initial direct costs | 5,000.00 |
Less lease incentive received | (12,000.00) |
Right-of-use asset, gross | $303,403.46 |
Straight-line amortisation, per month | $8,427.87 |
The event
Effective at the start of month 19 - 1 July 2026, the lessee and lessor agree to reduce the leased premises by 30%. Rent falls to $7,500 per month for the 18 months remaining. The lessee’s incremental borrowing rate at that date is 7.00%.
This is a decrease in scope that is not accounted for as a separate contract: no additional right of use is granted. It falls under ASC 842-10-25-13(b) and IFRS 16.46(a).
Step 1 - Remeasure the liability
This step is not controversial and does not vary by method. The revised payments are discounted at the revised rate, and the difference against the carrying liability is the reduction.
Liability at 1 July 2026 - identical under both methods | Amount |
|---|---|
Carrying lease liability before the modification | $172,586.32 |
Remeasured liability - PV of 18 x $7,500 at 7.00% | (128,546.51) |
Reduction in lease liability | $44,039.81 |
Step 2 - Reduce the right-of-use asset, and this is where they part
The carrying right-of-use asset immediately before the modification is $151,701.73 - the gross asset of $303,403.46 less 18 months of amortisation. Both standards require a proportionate reduction. The proportion is where the two methods diverge.
Method 1 reduces the asset in proportion to the right of use given up - the 30% of floor area handed back - and books a loss of $1,470.71. Method 2 reduces it in proportion to the decrease in the lease liability - 25.5176% - and books a gain of $5,329.24. The spread is $6,799.94 and the sign reverses.
Line item | Method 1 - right of use | Method 2 - liability decrease |
|---|---|---|
Right-of-use asset before modification | $151,701.73 | $151,701.73 |
Reduction basis | 30.0000% | 25.5176% |
Reduction in right-of-use asset | (45,510.52) | (38,710.58) |
Surviving right-of-use asset | $106,191.21 | $112,991.16 |
Reduction in lease liability | 44,039.81 | 44,039.81 |
Gain / (loss) to P&L | $(1,470.71) | $5,329.24 |
Why it reverses
The right-of-use asset and the lease liability do not run down at the same speed. The asset amortises on a straight line. The liability unwinds on an effective-interest curve and sits higher for longer. By month 19 the asset has fallen further, relative to its opening balance, than the liability has. Reducing the asset by the larger percentage (30%) therefore strips out more asset than liability, and the entry lands as a loss. Reducing it by the smaller percentage (25.5176%) leaves more asset behind than liability removed, and the entry lands as a gain.
The further into a lease the modification falls, the wider that gap opens.
The journal entries
Both entries are posted at 1 July 2026. Account codes shown are subledger detail accounts.
Method 1 - account | Description | Debit | Credit |
|---|---|---|---|
2200 | Lease liability | $44,039.81 | |
7200 | Lease modification gain / (loss) | 1,470.71 | |
1700 | Right-of-use asset | $45,510.52 | |
Total | $45,510.52 | $45,510.52 |
Method 2 - account | Description | Debit | Credit |
|---|---|---|---|
2200 | Lease liability | $44,039.81 | |
1700 | Right-of-use asset | $38,710.57 | |
7200 | Lease modification gain / (loss) | 5,329.24 | |
Total | $44,039.81 | $44,039.81 |
Figures are displayed to the cent and measured at full precision. The Method 2 right-of-use reduction measures at $38,710.5754 and is shown as $38,710.57 so the entry balances as presented.
The choice is timing, not cost
It is worth being precise about what the election does and does not change. It moves cost between periods. It does not change the total cost of the lease.
Component | Method 1 | Method 2 |
|---|---|---|
Interest expense, whole life | $28,636.35 | $28,636.35 |
Amortisation, whole life | 257,892.94 | 264,692.89 |
Less modification gain / add loss | 1,470.71 | (5,329.24) |
Total lease cost | $288,000.00 | $288,000.00 |
Independently: cash paid of $295,000.00, plus initial direct costs of $5,000.00, less the $12,000.00 incentive received, is $288,000.00. The two methods land on the same lifetime number by different routes. Method 1 takes a loss now and carries a smaller asset, so it amortises less later. Method 2 takes a gain now and amortises more later.
Proof
Every figure above comes out of a workbook that recomputes the lease on an independent second road and cross-foots the result. Three checks have to hold, and they hold to zero:
Check | What is proven | Result |
|---|---|---|
A | Carrying liability before the modification, taken from the amortisation schedule, agreed to the present value of the remaining original payments computed separately | $0.00 |
B | Surviving liability amortises to nil at the end of month 36 | $0.00 |
C | Lifetime cost identity - interest plus amortisation less the gain, against cash plus costs less incentives, under each method | $0.00 |
Two notes before you apply this
Operating leases under ASC 842. The mechanic above is unchanged - the asset is reduced and the difference goes to P&L. What changes is afterwards: the remaining cost is re-levelled to a single straight-line lease cost over the remaining term under ASC 842-20-25-8, rather than presented as interest and amortisation. The lifetime total is the same $288,000.00.
It is a policy election, so it has to behave like one. Pick a basis, apply it to every scope decrease, and disclose it. What you cannot do is choose per modification - which is exactly what happens when the calculation lives in a spreadsheet that a different person rebuilds each time. On a portfolio with regular give-backs this is a real audit exposure, and it is the kind of inconsistency that only surfaces when someone reads across several years of modifications at once.
Request the worked example
Every figure on this page comes out of one Excel workbook. It is fully formula-driven and open - not a PDF of results. Change the termination month or the proportion and the schedules, the entries and the sign all move with it.
Tab | What is on it |
|---|---|
1 | Facts and computation. Every input above, plus two complete monthly liability schedules built side by side - the original payments at the original rate, and the revised payments at the revised rate. Period, date, payment, opening, balance after payment, interest, closing. Every cell a formula. |
2 | Termination divergence. The two methods worked in parallel - reduction basis, right-of-use reduction, surviving asset, and the gain or loss under each, with the spread between them isolated on its own line. |
3 | Reconciliation and identity. The three tie-outs, live: the carrying liability proven on a second independent road, the surviving liability run to nil at term, and the lifetime-cost identity under each method against cash plus costs less incentives. |
0 | Index. A one-page map of the above, so it can be handed to a reviewer without a walkthrough. |
The workbook is sent by email rather than downloaded, so tell me briefly what you are working on - a live modification, an audit question, a policy you are setting. It usually means I can send something closer to your facts than the generic file.
This worked example uses an illustrative fact pattern prepared by Fractional AI Lease Controllers, Inc. It is published for technical reference and is not accounting advice. Applying a method to your own portfolio depends on facts, existing policy elections and materiality.