Background of the Issue

We hold a leasehold improvement asset. At initial recognition of the related lease, we expected to exercise the renewal option, which would extend the lease term by an additional 5 years. Based on this expectation, the depreciation (amortization) period of the improvement asset was correspondingly extended.

However, as the lease term approaches its end, we have now determined that we will not exercise the renewal option. This gives rise to the following accounting questions:

  • At the expiration of the lease, should the unamortized balance of the improvement asset be fully expensed in one lump sum?
  • Should the useful life and amortization policy of the improvement asset be reassessed annually?
  • In the current year, given that it is known that the lease will not be renewed, should accelerated amortization expense begin immediately?
  • Is there clear accounting standard guidance for the above situation?

It should be specifically noted that this situation does not constitute a lease modification; it is merely a change in accounting estimate. Regardless of the treatment, it will not affect the classification of the lease (finance lease or operating lease).

Analysis of Core Accounting Principles

I. Basis for Determining the Amortization Period

Under current accounting standards (such as the Accounting Standards for Business Enterprises No. 4 - Fixed Assets and similar provisions under International Financial Reporting Standards (IFRS) for right-of-use assets and leasehold improvements), the depreciation (amortization) period of a leasehold improvement asset should be the shorter of itsuseful lifeandremaining lease term. Here, the "lease term" should include the period covered by renewal options that are reasonably certain to be exercised.

When it is reasonably certain at initial recognition that the renewal option will be exercised, the amortization period may cover the renewal period. However, if subsequent circumstances change such that it is no longer reasonably certain that the option will be exercised, the remaining lease term should be shortened accordingly.

II. Treatment of Changes in Accounting Estimates

The situation you describe—changing from "expected renewal" to "determined not to renew"—is a typicalchange in accounting estimate. According to the Accounting Standards for Business Enterprises No. 28 - Changes in Accounting Policies, Accounting Estimates and Corrections of Errors, changes in accounting estimates should be accounted for using theprospective application method, meaning that prior periods are not retrospectively adjusted; instead, the new estimate is applied in the period of change and future periods.

Therefore,it should notbe fully expensed in one lump sum at lease expiration, unless that point happens to be the end of the revised remaining amortization period. The correct approach is: in the period in which the change occurs (i.e., the current year), recalculate the amortization of the remaining carrying amount over the revised remaining lease term.

III. Requirement for Annual Reassessment

An entity shouldat each balance sheet datereview the useful life, expected net residual value, and depreciation method of fixed assets (including leasehold improvements). When there is a difference between the expected useful life and the original estimate, the amortization period should be adjusted. Similarly, for renewal options that affect the determination of the lease term, an assessment should be made at each reporting date as to whether it remains "reasonably certain" that the option will be exercised.

In this case, since it has been determined in the current year that the lease will not be renewed, the remaining amortization period should be adjusted immediately, rather than waiting until lease expiration to address it.

IV. Specific Operation of Accelerated Amortization

Assume the original lease term had 5 years remaining (including the renewal period), and it is now decided not to renew. The remaining lease term would be shortened to the remaining portion of the original base lease term (for example, if the original base lease term was 10 years and 7 years have passed, then 3 years remain). At this point, the unamortized net carrying amount of the improvement asset should be amortized over therevised remaining lease term (e.g., 3 years)using the original depreciation method (usually the straight-line method).

This means that, starting from the current year, the annual amortization amount will increase significantly (because the denominator becomes smaller), but it will not be fully expensed in one lump sum. If the revised remaining lease term is zero (i.e., the lease terminates immediately), the remaining carrying amount should be fully recognized in profit or loss on the termination date.

Conclusion and Recommendations

Core conclusion: The full balance should not be expensed in one lump sum at the end of the period; a change in accounting estimate should be recognized in the current year, and the remaining carrying amount should be systematically amortized over the revised remaining lease term (rather than the original term including the renewal period). Annual reassessment is necessary, and an adjustment should be made immediately in the current year.

Relevant guidance is primarily found in Article 19 of the Accounting Standards for Business Enterprises No. 4 - Fixed Assets (review of useful life) and the provisions of the Accounting Standards for Business Enterprises No. 21 - Leases regarding the determination of the lease term and the assessment of renewal options. Under IFRS, reference can be made to IAS 16 (Property, Plant and Equipment) paragraphs 50-51 and IFRS 16 (Leases) paragraphs B34-B35.

It is recommended that your company prepare a statement of changes in accounting estimates in the period of change, documenting the original estimation basis, the new estimation basis, and the impact on profit or loss for the current and future periods, to meet audit and disclosure requirements.