What goes into the lease term?
- The non-cancellable period, during which the lessee has the right to use the asset.
- Periods covered by an option to extend, if the lessee is reasonably certain to exercise it.
- Periods covered by an option to terminate, if the lessee is reasonably certain not to exercise it.
A lease is no longer enforceable when both lessee and lessor can each terminate it without permission from the other and with no more than an insignificant penalty. The penalty includes economic costs, not just contractual payments, so a lessee that would lose valuable improvements by leaving may face a significant penalty even without a termination fee.
What makes an option reasonably certain to be used?
| Factor | Points towards using an extension option when |
|---|---|
| Rent in the option period | It is below market |
| Leasehold improvements | Significant improvements would still have value at the option date |
| Costs of leaving | Relocation, negotiation or disruption costs are high |
| Importance of the asset | It is specialised or critical, such as a key factory or network site |
| Past practice | The company usually renews similar leases |
| Short non-cancellable period | The shorter it is, the more likely an option will be used |
A worked example: an office with an option
A company leases an office for five years at CU 100,000 a year, with an option to extend for five more years at the same rent. It is spending heavily to fit out the space, which will last ten years, and moving would disrupt its business. It judges that it is reasonably certain to extend, so the lease term is ten years.
| Lease term | Lease liability at 5% | Yearly depreciation |
|---|---|---|
| Five years | CU 432,948 | CU 86,590 |
| Ten years | CU 772,173 | CU 77,217 |
The judgement adds CU 339,226 to the liability. Change the term in the Lease calculator (Excel) to see the full effect on the schedule.
How do termination options work?
The same logic in reverse. A ten-year lease that the lessee may end after year five by paying six months' rent has a lease term of ten years unless the lessee is reasonably certain to terminate. A termination option held only by the lessor is ignored, because the lessee cannot avoid the payments: the lease term includes the period after the lessor's option date.
When is the term reassessed?
A lessee reassesses whether it is reasonably certain to exercise an option only after a significant event or change in circumstances that is within its control and affects the assessment, such as making significant leasehold improvements not anticipated at the start, or a significant business decision directly relevant to the option. Changes in market rents alone do not trigger reassessment. The term also changes if the lessee actually exercises, or fails to exercise, an option in a way not previously assumed.
When the term changes, the lessee remeasures the liability using a revised discount rate and adjusts the right-of-use asset by the same amount.
Common mistakes
- Ignoring options because the company "has not decided yet": the test is reasonable certainty, judged now.
- Using the useful life of leasehold improvements without asking whether the lease will in fact run that long.
- Treating rolling leases that either party can end freely as long-term leases.
Where to go next
With the term set, measure the lease as in lessee accounting step by step. For short leases, see the short-term exemption.
Need help applying the standards?
Our Chartered Accountants help finance teams and students apply IFRS and US GAAP to real transactions.
Questions people ask
What is the lease term under IFRS 16?
The non-cancellable period plus periods covered by options the lessee is reasonably certain to exercise, or not to exercise in the case of termination options.
What does reasonably certain mean for lease options?
A high threshold, judged on all relevant economic factors such as below-market rents, leasehold improvements and relocation costs.
When is the lease term reassessed?
After a significant event or change in circumstances within the lessee's control that affects whether an option will be used.
Does the lease term affect the lease liability?
Yes. A longer term includes more payments, so the liability and the right-of-use asset are larger.
Sources
Every fee, date and rule on this page was taken from these official and primary sources.
Rules and fees change. If you are reading this long after October 4, 2026, confirm the figures with the source before you rely on them.
Related guides
More in IFRS 16
This guide is general information. It is not tax or legal advice for your situation.