Currently I am facing challenges to determine the lease term under IFRS 16 Lease. My company usually enters with a site/location rental contract with multiple landlord's mostly for 5 years tenure. The agreement says that in the first 3 years of the agreement neither party to the contract can cancel the agreement. However, at the end of 3 years lock-in period either party can terminate the lease with a 6 months prior notice.
As per para B34 lease term is defined as "In determining the lease term and assessing the length of the non-cancellable period of a lease, an entity shall apply the definition of a contract and determine the period for which the contract is enforceable. A lease is no longer enforceable when the lessee and the lessor each has the right to terminate the lease without permission from the other party with no more than an insignificant penalty."
And as per para BC128 it is stated that "Accordingly, if the lessee has the right to extend or terminate the lease, there are enforceable rights and obligations beyond the initial non-cancellable period and the parties to the lease would be required to consider those optional periods in their assessment of the lease term. In contrast, a lessor's right to terminate a lease is ignored when determining the lease term because, in that case, the lessee has an unconditional obligation to pay for the right to use the asset for the period of the lease, unless and until the lessor decides to terminate the lease."
In reality, 99% case my company stay with the leased locations and though landlord has the right to terminate the lease after lock-in period of 3 years it rarely happen. My consultant is in the view that lease term is 3.5 years (lock-in period plus notice period). This creates severe anomalies in recognition of assets because of the following:
For a lease, first 3.5 years it is lease and next 1.5 years it is service contract and when renewed again after expiry of the 5 years agreement period similar treatment continues i.e. first 3.5 years it is lease and next 1.5 years it is service contract.
Can you please advise me exactly what would be the lease term?
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