How should the modification in the lease agreement with SPL be accounted for?

(a) Ind AS 116 on leases provides guidelines on accounting for lease modifications. Lease modification includes change in scope of the lease e.g. extending the contractual lease term. In this case, modification increases the scope of the lease by extending the contractual lease term from original term of 5 years to a total of 8 years. At the effective date of the modification (at the beginning of Year 4), FPL would remeasure the lease liability based on: (a) A five-year remaining lease term (b) Annual payments of 10,00,000 payable at the end of each year and (c) FPL's incremental borrowing rate of 7% p.a. The modified lease liability equals - 41,00,000 (refer working note 3). The lease liability immediately before the modification (including the recognition of interest expense until the end of Year 3) is 18,32,959. FPL will account for the modification in the lease agreement with SPL as follows:- At the beginning of Year 4, on the effective date of modification FPL will recognize the difference between the carrying amount of lease liability - 18,32,959 (immediately before the modification) and the carrying amount of the modified lease liability - 41,00,000. Modified lease liability 41,00,000. Less: Original lease liability as at the modification date (beginning of Year 4) 18,32,959 This difference would result in an increase in lease liability and carrying amount of ROU asset by 22,67,041 Working Note 1: Calculation of the Lease at the commencement of the lease Year Lease Payment (A) PV Factor @6% (B) Present Value of Lease Payments C = A × B 1 10,00,000 0.943 9,43,000 2 10,00,000 0.89 8,90,000 3 10,00,000 0.84 8,40,000 4 10,00,000 0.792 7,92,000 5 10,00,000 0.747 7,47,000 Total 50,00,000 42,12,000 Working Note 2: Calculation of Lease liability immediately before modification date Year Opening Lease Liability (A) Interest @ 6% B = (A) x 6% Lease Payments Closing Liability = A + B - C 1 42,12,000 2,52,720 10,00,000 34,64,720 2 34,64,720 2,07,883 10,00,000 26,72,603 3 26,72,603 1,60,356 10,00,000 18,32,959 Working Note 3: Calculation of modified lease liability on date of modification Year Lease Payment (A) PV Factor @7% (B) Present Value of Lease Payments C = A × B 4 10,00,000 0.935 9,35,000 5 10,00,000 0.873 8,73,000 6 10,00,000 0.816 8,16,000 7 10,00,000 0.763 7,63,000 8 10,00,000 0.713 7,13,000 Total 50,00,000 41,00,000