IFRS 16 Leases
IFRS 16 – Leases is an international accounting standard that brought significant changes to lease accounting, replacing IAS 17 and effective from 1 January 2019.
Under IFRS 16, lessees are required to recognize on the balance sheet:
- A Right-of-Use (ROU) Asset: representing the lessee’s right to use the leased asset.
- A Lease Liability: representing the present value of future lease payments.
Question: Are there any exceptions to the application of IFRS 16?
There are two exceptions to this rule, and they are:
- Short-term leases (12 months or less), and
- Low-value assets (e.g., tablets, small office furniture).
Question: Does IFRS 16 have a greater impact on lessees or lessors?
- Lessees: Entities that lease assets are the most impacted by IFRS 16. They are now required to recognize most leases on the balance sheet, resulting in substantial changes to financial reporting and key performance metrics. Under IFRS 16, the lessee:
- Calculates the present value (PV) of lease payments.
- Recognizes a ROU asset and a lease liability of that present value.
- Depreciates the asset over the lease term.
- Recognizes interest expense on the lease liability.
- Lessors: (owners of the asset) see minimal changes as compared to IAS 17.
Question: What are the common challenges in implementing IFRS 16?
Implementation Roadmap for IFRS 16
Implementing International Financial Reporting Standards (IFRS) is a significant shift for any organization as it involves changes in accounting policies, systems, processes, and training. Below are the key steps for IFRS 16 implementation:
- Project Planning
- Establish an implementation team (finance, accounting, legal, IT).
- Define the scope, timeline, and resources needed for the project.
- Read and understand IFRS 16 thoroughly.
- Lease Identification
- Review all contracts to identify leases or lease-like arrangements.
- Data Collection
- Collect key lease data from lease agreement such as:
- Lease term with start and end dates,
- Payment amounts and frequency,
- Renewal and termination options.
- Discount rates or implicit rates: We can use the Interest Rate Implicit in the Lease (IRR), if known, or use Incremental Borrowing Rate (IBR) if IRR is not known. This is the rate the lessee would have to pay to borrow over a similar term with similar security.
- Lease Assessment
- Determine whether each contract meets the definition of a lease under IFRS 16.
- Assess lease term, including renewals or early termination.
- Identify short-term leases or low-value assets eligible for exemptions.
- Calculation of Present Value
- Now, the more technical part is to calculate the Present Value (PV) of lease payments to recognize the:
- Right-of-use (ROU) asset,
- Lease liability,
- Depreciation and interest expense.
- Systems Tools
- Decide whether to use spreadsheets or lease accounting software.
- Integrate with the ERP or accounting software, if possible.
- Journal Entries & Financial Reporting
- Post initial recognition entries (ROU asset and lease liability).
- Prepare ongoing monthly/quarterly/annual entries:
- Depreciation of ROU asset
- Interest on lease liability
- Update disclosures in financial statements as required by IFRS 16.
- Policy Updates & Training
- Update internal accounting policies and procedures to reflect IFRS 16.
- Provide training to finance, accounting, and operational teams.
- Develop controls for ongoing lease management.
- Audit
- Work with external auditors to ensure proper disclosures.
- Document all assumptions, such as discount rates.
- Go-Live
- Finalize system go-live and transition accounting entries.
- Monitor ongoing leases for any updates.
Question: Can you provide a practical example of accounting for a lease by a lessee?
Practical Example
Now we will implement IFRS 16 with a real-life example for better understanding:
- Lease Term: 5 years
- Lease Payments: $1,00,000 per annum
- Payment Timing: Beginning of each year (annuity due)
- Discount Rate: 6%
To make it simple to understand, I have put column numbers from 1 to 13 on top of the table and I will explain each step.
Column 1: Years of lease
Column 2: Date of payments of lease or rentals
Column 3: Payment amounts as agreed in the lease agreement
Column 4: Formula = D10/(1+$C$7), First year no interest as paid in advance.
Column 5: Formula =C10*D10
Column 6: Total of Col 5 is opening of Col 6 (Total of PV)
Column 7: Formula =F11*$C$7
Column 8: Formula =C11-G11
Column 9: Formula =F10-H10
Column 10: Starts with the Total of PV and is equal to Lease Liability and minus depreciation each year.
Column 11: Depreciation is equal amounts and calculated on the Opening ROU / Lease term.
Column 12: Formula =J10-K10
Column 13: This is the total of each year’s interest and depreciation, and formula =G10+K10
Please review my blog on leases here: https://accountingblogger.com/ifrs-16-leases/
Question: Can you provide the journal entries for Year 1 to Year 5 of lease?
Entries in Books of Accounts
First Year – 2025
Initial Recognition (on lease commencement)
- Debit: Right-of-Use Asset (ROU) $ 446,511
- Credit: Lease Liability $ 446,511
First Payment in Advance, so no interest portion
- Debit: Interest Expense $ 0
- Debit: Lease Liability $ 100,000
- Credit: Bank / Cash $100,000
Entries on 31 December,2025
- Debit: Depreciation Expense $ 89,302
- Credit: Accumulated Depreciation-ROU Asset $ 89,302
Second Year – 2026
- Debit: Interest Expense $ 20,791
- Debit: Lease Liability $ 79,209
- Credit: Bank / Cash $100,000
Entries on 31 December,2026
- Debit: Depreciation Expense $ 89,302
- Credit: Accumulated Depreciation-ROU Asset $ 89,302
Third Year – 2027
- Debit: Interest Expense $ 16,038
- Debit: Lease Liability $ 83,962
- Credit: Bank / Cash $100,000
And
- Debit: Depreciation Expense $ 89,302
- Credit: Accumulated Depreciation-ROU Asset $ 89,302
Fourth Year – 2028
Entries on 31 December,2028
- Debit: Interest Expense $ 11,000
- Debit: Lease Liability $ 89,000
- Credit: Bank / Cash $100,000
And
- Debit: Depreciation Expense $ 89,302
- Credit: Accumulated Depreciation-ROU Asset $ 89,302
Fifth & Final Year – 2029
Entries on 31 December,2029
- Debit: Interest Expense $ 5,660
- Debit: Lease Liability $ 94,340
- Credit: Bank / Cash $100,000
And
- Debit: Depreciation Expense $ 89,302
- Credit: Accumulated Depreciation-ROU Asset $ 89,302
Cross Check:
At the end of the lease term, the right-of-use asset, net of accumulated depreciation, and the corresponding lease liability will both be fully reduced to zero, reflecting the full consumption of the asset and settlement of all lease obligations.
Please review my blog on leases here: https://accountingblogger.com/ifrs-16-leases-accounting-treatment/
IFRS 16 – Leases | Accounting Treatment | Humayun Atif (CMA)
Presentation in Financial Statements
Now, we will discuss the impact and presentation of leases in the Financial Statement as below:
Question: How does IFRS 16 impact the income statement?
Under IFRS 16, the lease expense (which used to be a single operating lease cost under IAS 17) is split into:
- Depreciation Expense of Right-of-use assets
- Finance Cost – Lease Liability
Net Income
Total net income will be the same over the lease term, but lower in early years (due to front-loaded interest).
Question: How does IFRS 16 affect the balance sheet?
Balance Sheet Impact (Lessees)
Under IFRS 16, lessees recognize two key items on the balance sheet:
- Right-of-Use Asset (ROU)
- Lease Liability – Shown separately into Current and Non-Current Portion
Final Thought on IFRS 16 – Leases
IFRS 16 represents a significant step forward in improving the transparency and comparability of financial reporting. By requiring most leases to be recognized on the balance sheet, the standard offers enhanced visibility into a company’s lease obligations, reduces the scope for off-balance sheet financing, and ensures that lease accounting more accurately reflects the economic substance of leasing arrangements.
A key feature of IFRS 16 Leases is the separation of lease payments into a depreciation and interest component. This approach provides a more precise reflection of how the economic benefits of leased assets are consumed over time.
IFRS 16 also brings lease accounting in closer alignment with U.S. GAAP (ASC 842) and other global accounting frameworks, facilitating compliance for multinational entities and supporting consistency in financial reporting across jurisdictions.
Unlike IAS 17, which permitted straight-line lease expense recognition, IFRS 16 results in front-loaded lease expenses due to the interest element in the early years of the lease term. While this may lead to lower net income in the initial periods and affect year-on-year comparability, the overall lease cost over the term remains unchanged.
Moreover, the standard fosters greater consistency in lease reporting across industries, enabling stakeholders to better assess an entity’s financial position and performance.
IFRS 16 extends its impact well beyond lease accounting, fundamentally reshaping how companies present their financial position and performance. Its implementation has ripple effects across several other IFRS and IAS standards, requiring entities to carefully assess and manage these interdependencies both during adoption and in ongoing financial reporting.
While IFRS 16 presents certain implementation challenges, its overall contribution to enhanced financial transparency, consistency, and comparability represents a significant and necessary advancement in accounting standards. It is a welcome development, particularly from the perspective of promoting financial integrity and improved stakeholder insight.
ABOUT THE AUTHOR
Humayun Atif | CMA, CPA, CA (FIN), MS-IT, CA Articles from Big 4, Certified Forensic Accountant (USA), Six Sigma, Microsoft & Oracle Certified.
Atif is passionate about Business, Tech, and the written word. He is the author of the book ‘IFRS Made Easy’. He is a Tech, Tax and IFRS coach and the founder of accountingblogger.com
