Right-of-use assets and lease liabilities for premises

Warehouse, distribution center and terminal leases held by the logistics company as lessee are recognized on-balance-sheet as right-of-use assets and lease liabilities, requiring identification of the lease term including renewal options reasonably certain to be exercised. Understating the lease term (e.g. ignoring near-certain renewals) understates both the asset and liability and distorts future depreciation/interest patterns, misleading lenders assessing balance sheet leverage.

What is the non-cancellable period of each premises lease, and are renewal or termination options reasonably certain to be exercised given the strategic importance of the location, relocation costs, and past renewal behaviour? Which discount rate is used to measure the lease liability, and does it properly reflect the term, currency, and economic environment of the specific asset (e.g., a long-term logistics-zone land lease versus a short urban warehouse)? Are variable payments linked to throughput or storage volume identified and excluded from (or included in, if in-substance fixed) the lease liability?

1) Identify the non-cancellable period of the lease. 2) Assess whether renewal options are reasonably certain to be exercised, considering the strategic importance of the location, relocation/switching costs, and past renewal behavior; include such periods in the lease term. 3) Assess termination options similarly, exclude periods covered by a termination option only if exercise is reasonably certain. 4) Recognize a right-of-use asset and lease liability at commencement for the resulting lease term, unless short-term or low-value exemptions apply. 5) Separate genuinely variable payments (linked to throughput/volume) from in-substance fixed payments; include only the latter in the lease liability, expensing true variable payments as incurred. 6) Reassess the lease term when a significant event or change in circumstances affects the renewal/termination assessment (a trigger for remeasurement, not merely a periodic review).

Measure the lease liability at the present value of fixed and in-substance fixed payments over the reassessed lease term, discounted at the incremental borrowing rate reflecting the term, currency, and economic environment of the specific asset (e.g. long-term industrial land in a logistics zone may carry a different rate profile than a short urban warehouse lease). Remeasure the lease liability and right-of-use asset when the lease term is reassessed, using a revised discount rate at the date of reassessment.

Disclose: (1) right-of-use assets and lease liabilities by class (warehouse, terminal, office); (2) variable lease payments not included in the liability and expensed as incurred; (3) the total cash outflow for leases during the period; (4) significant judgments in assessing lease term (renewal/termination reasonable certainty); (5) any remeasurement of the lease liability and right-of-use asset during the period and the triggering event.

• Using only the initial non-cancellable term when renewal is reasonably certain given the strategic location and high switching costs, understating the lease liability and asset
• treating volume-based storage fees as fixed payments requiring capitalization when they are genuinely variable, overstating the liability
• failing to reassess the lease term when circumstances change materially (e.g. a major capex investment at the site strongly implying renewal)
• applying a single blanket discount rate across leases with very different terms and currencies.