How are variable lease payments treated under IFRS 16?

Core rule Under IFRS 16, variable lease payments are split into two categories: those that depend on an index or rate are included in the initial lease liability measurement, while all other variable payments (linked to usage, performance, or other factors) are excluded from the lease liability and expensed as incurred. How it works - Variable payments tied to an index or rate (e.g., CPI-linked rent, LIBOR-based payments) are included in the lease liability at commencement, measured using the index or rate at that date (IFRS 16.28(b)). These are not estimates of future variability — you use the current index value, not a forecast. - Variable payments NOT tied to an index or rate (e.g., turnover rent, usage-based charges, performance contingencies) are entirely excluded from the lease liability and right-of-use (ROU) asset at commencement. They are recognised in profit or loss in the period in which the triggering event occurs (IFRS 16.38). - Remeasurement of the lease liability is required when there is a change in future lease payments resulting from a change in an index or rate. The lessee remeasures the lease liability using a revised discount rate onl

When a CPI-linked lease has both a floor and a cap on annual increases, how should the lease liability be measured and remeasured under IFRS 16.28(b) and 16.45(c)?

y if the change results from a floating interest rate; for index/rate changes, the original discount rate is retained (IFRS 16.45(c), IFRS 16.42(b)). The adjustment is made to the carrying amount of the ROU asset. - In-substance fixed payments — variable payments that are, in reality, unavoidable (e.g., where all scenarios lead to the same payment) are treated as fixed lease payments and included in the lease liability (IFRS 16.B42). This is a significant judgment area that auditors scrutinise closely. - Lease incentives and variable payments interaction: Remeasurement of the lease liability for index changes flows through the ROU asset, not through profit or loss directly, preserving the balance sheet grossing-up effect central to IFRS 16 lessee accounting (IFRS 16.39). - Disclosure: Lessees must disclose the total variable lease expense not included in the lease liability, the carrying amount of the ROU asset, and a maturity analysis of lease liabilities (IFRS 16.53(d), IFRS 16.58). Practical example Scenario: A retailer signs a 5-year lease. Annual fixed rent is €120,000. The lease also includes a turnover rent of 2% of annual sales (excluded variable)

How do you assess whether a variable turnover-based rent clause constitutes an in-substance fixed payment under IFRS 16.B42, and what evidence should auditors expect?

and an annual CPI uplift starting Year 2 (CPI-linked variable). At commencement, CPI is 3%; the incremental borrowing rate is 5%. Year 2 CPI rises to 5%, increasing annual rent by €2,400. At commencement — lease liability based on €120,000 × annuity factor (5 years, 5%) = €519,768. Year 2 remeasurement — revised annual payment becomes €122,400. Revised lease liability = €122,400 × remaining annuity factor (4 years, 5%) = €433,627 vs. carrying amount of €426,206 (post Year 1 unwind). Difference of €7,421 is added to the ROU asset. | Account | Dr (€) | Cr (€) | |---|---|---| | Right-of-use asset | 7,421 | | | Lease liability | | 7,421 | Turnover rent — if sales in Year 1 are €2,000,000, variable rent = €40,000, recognised immediately: | Account | Dr (€) | Cr (€) | |---|---|---| | Variable lease expense (P&L) | 40,000 | | | Accruals / Cash | | 40,000 | Common pitfalls - Misclassifying in-substance fixed payments as variable: Lease contracts often include clauses that appear contingent but are practically unavoidable (e.g., a "variable" charge applying to all possible usage levels). Failing to include these in the lease liability understates both the ROU ass

If a lessee transitions from a variable interest rate to a fixed rate mid-lease (e.g., via an interest rate swap), how does this affect lease liability remeasurement under IFRS 16.45?

et and the lease obligation — a material audit risk under IFRS 16.B42. - Using forecast index values instead of current index at remeasurement: IFRS 16.45(c) requires use of the index or rate at the date of remeasurement, not a projected future rate. Using CPI forecasts inflates the lease liability and distorts depreciation charges on the ROU asset. - Incorrect discount rate on remeasurement: When an index or rate change triggers remeasurement, the original effective interest rate is retained (IFRS 16.45(c)), not the current market rate. Applying the current borrowing rate to an index-linked remeasurement is a common error that artificially changes the liability balance. Key paragraphs to know - IFRS 16.28(b) — initial measurement: inclusion of index/rate-linked variable payments in lease liability. - IFRS 16.38 — recognition of variable payments not in the lease liability as period expenses. - IFRS 16.42(b) and IFRS 16.45(c) — remeasurement triggers and methodology for index/rate changes. - IFRS 16.B42 — definition and treatment of in-substance fixed payments. - IFRS 16.53(d) — disclosure of variable lease expense excluded from lease liability measuremen

IFRS 16 Variable Lease Payments

IFRS 16 Variable — Core Rule

Under IFRS 16, variable lease payments are split into two categories: those that depend on an index or rate are included in the initial lease liability measurement, while all other variable payments (linked to usage, performance, or other factors) are excluded from the lease liability and expensed as incurred.

How IFRS 16 Variable Works

Variable payments tied to an index or rate (e.g., CPI-linked rent, LIBOR-based payments) are included in the lease liability at commencement, measured using the index or rate at that date (IFRS 16.28(b)). These are not estimates of future variability — you use the current index value, not a forecast.

Variable payments NOT tied to an index or rate (e.g., turnover rent, usage-based charges, performance contingencies) are entirely excluded from the lease liability and right-of-use (ROU) asset at commencement. They are recognised in profit or loss in the period in which the triggering event occurs (IFRS 16.38).

Remeasurement of the lease liability is required when there is a change in future lease payments resulting from a change in an index or rate. The lessee remeasures the lease liability using a revised discount rate only if the change results from a floating interest rate; for index/rate changes, the original discount rate is retained (IFRS 16.45(c), IFRS 16.42(b)). The adjustment is made to the carrying amount of the ROU asset.

In-substance fixed payments — variable payments that are, in reality, unavoidable (e.g., where all scenarios lead to the same payment) are treated as fixed lease payments and included in the lease liability (IFRS 16.B42). This is a significant judgment area that auditors scrutinise closely.

Lease incentives and variable payments interaction: Remeasurement of the lease liability for index changes flows through the ROU asset, not through profit or loss directly, preserving the balance sheet grossing-up effect central to IFRS 16 lessee accounting (IFRS 16.39).

Disclosure: Lessees must disclose the total variable lease expense not included in the lease liability, the carrying amount of the ROU asset, and a maturity analysis of lease liabilities (IFRS 16.53(d), IFRS 16.58).

IFRS 16 Variable — Practical Example

Scenario: A retailer signs a 5-year lease. Annual fixed rent is €120,000. The lease also includes a turnover rent of 2% of annual sales (excluded variable) and an annual CPI uplift starting Year 2 (CPI-linked variable). At commencement, CPI is 3%; the incremental borrowing rate is 5%. Year 2 CPI rises to 5%, increasing annual rent by €2,400.

At commencement — lease liability based on €120,000 × annuity factor (5 years, 5%) = €519,768.

Year 2 remeasurement — revised annual payment becomes €122,400. Revised lease liability = €122,400 × remaining annuity factor (4 years, 5%) = €433,627 vs. carrying amount of €426,206 (post Year 1 unwind). Difference of €7,421 is added to the ROU asset.

Account	Dr (€)	Cr (€)
Right-of-use asset	7,421
Lease liability		7,421

Turnover rent — if sales in Year 1 are €2,000,000, variable rent = €40,000, recognised immediately:

Account	Dr (€)	Cr (€)
Variable lease expense (P&L)	40,000
Accruals / Cash		40,000

IFRS 16 Variable — Common Pitfalls

Misclassifying in-substance fixed payments as variable: Lease contracts often include clauses that appear contingent but are practically unavoidable (e.g., a "variable" charge applying to all possible usage levels). Failing to include these in the lease liability understates both the ROU asset and the lease obligation — a material audit risk under IFRS 16.B42.

Using forecast index values instead of current index at remeasurement: IFRS 16.45(c) requires use of the index or rate at the date of remeasurement, not a projected future rate. Using CPI forecasts inflates the lease liability and distorts depreciation charges on the ROU asset.

Incorrect discount rate on remeasurement: When an index or rate change triggers remeasurement, the original effective interest rate is retained (IFRS 16.45(c)), not the current market rate. Applying the current borrowing rate to an index-linked remeasurement is a common error that artificially changes the liability balance.

IFRS 16 Variable — Key Paragraphs

IFRS 16.28(b) — initial measurement: inclusion of index/rate-linked variable payments in lease liability.
IFRS 16.38 — recognition of variable payments not in the lease liability as period expenses.
IFRS 16.42(b) and IFRS 16.45(c) — remeasurement triggers and methodology for index/rate changes.
IFRS 16.B42 — definition and treatment of in-substance fixed payments.
IFRS 16.53(d) — disclosure of variable lease expense excluded from lease liability measurement.