How does lease accounting work under IFRS 16?

IFRS 16 Leases requires lessees to recognise a right-of-use (ROU) asset and a lease liability on the balance sheet for virtually all leases. This replaces the former operating/finance lease distinction under IAS 17 and ensures that lease obligations are transparently reflected on the face of financial statements. The standard applies to all leases, with limited exceptions including leases of minerals, biological assets, and service concession arrangements (IFRS 16.3). Lessees may elect practical exemptions for short-term leases and leases of low-value assets, recognising payments for those leases as an expense on a straight-line basis instead (IFRS 16.5, IFRS 16.6). - Identifying a lease (IFRS 16.9): At inception, an entity assesses whether a contract is, or contains, a lease — that is, whether it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. This assessment is only revisited if the contract terms change (IFRS 16.11). - Commencement date recognition (IFRS 16.22): A lessee recognises both a ROU asset and a lease liability at the commencement date. The ROU asset is initially measured at cost (IFRS 16.23), which includes the initial measurement of the lease liability, any lease payments made before commencement less incentives received, initial direct costs, and estimated restoration costs (IFRS 16.24).

How do you determine the incremental borrowing rate when the implicit lease rate is unknown, and what evidence satisfies auditors?

- Lease liability initial measurement (IFRS 16.26): The lease liability equals the present value of lease payments not yet paid at the commencement date, discounted using the interest rate implicit in the lease or, if that cannot be readily determined, the lessee's incremental borrowing rate. - Lease payments included in the liability (IFRS 16.27): Amounts included in the measurement comprise fixed payments, variable payments linked to an index or rate, amounts under residual value guarantees, and exercise prices of purchase options the lessee is reasonably certain to exercise, as well as early termination penalties where termination is reasonably certain. - Subsequent measurement of the lease liability (IFRS 16.36): After commencement, the lease liability is increased to reflect interest accruing on the outstanding balance, reduced by lease payments made, and remeasured to reflect any reassessments or lease modifications. - Profit or loss (IFRS 16.38): A lessee recognises interest on the lease liability and any variable lease payments not included in the original measurement directly in profit or loss as those payments are triggered.

What is the accounting treatment for a lease modification under IFRS 16.39–43, and when is a remeasurement of the liability required?

- ROU asset — depreciation and impairment: The ROU asset is depreciated applying IAS 16 principles (IFRS 16.31). If the lease transfers ownership or the lessee is reasonably certain to exercise a purchase option, depreciation runs to the end of the asset's useful life; otherwise it runs to the end of the lease term (IFRS 16.32). The ROU asset must also be tested for impairment under IAS 36 (IFRS 16.33). - Statement of cash flows (IFRS 16.50): Principal repayments on the lease liability are classified within financing activities; interest payments follow IAS 7 requirements; short-term lease payments and low-value lease payments are presented within operating activities. - Lease term underestimation: Renewal options must be included in the lease term when the lessee is reasonably certain to exercise them (IFRS 16.18). Ignoring economically compelling renewal options understates both the ROU asset and the lease liability. - Wrong discount rate: Using a rate other than the interest rate implicit in the lease — when that rate can be readily determined — is non-compliant. Only where it cannot be determined may the incremental borrowing rate be used (IFRS 16.26).

How do the short-term lease exemption (IFRS 16.5–6) and low-value asset exemption (IFRS 16.3–4) work in practice, and what is the audit risk?

- Failing to reassess the lease term: A lessee must reassess whether it is reasonably certain to exercise an extension or termination option when a significant event or change in circumstances occurs that is within the lessee's control (IFRS 16.20). - Misclassifying contract components: Each lease component must be accounted for separately from non-lease components unless the lessee elects the practical expedient to combine them (IFRS 16.12). Bundling service and lease elements without proper allocation inflates ROU assets. - Overlooking exemptions: The short-term and low-value exemptions are elective and applied by class of asset (IFRS 16.8). Inconsistent application across similar asset classes is a common compliance gap. - IFRS 16.9 — Defines when a contract is, or contains, a lease based on control of an identified asset. - IFRS 16.22 — Requires recognition of both the ROU asset and lease liability at the commencement date. - IFRS 16.26 — Sets out initial measurement of the lease liability at present value, using the implicit rate or incremental borrowing rate. - IFRS 16.24 — Specifies all components of the cost of the ROU asset at initial measurement. - IFRS 16.36 — Governs subsequent measurement of the lease liability, covering interest accretion, repayments, and remeasurement. - IFRS 16.18 — Defines lease term, including reasonably certain extension and termination options.

IFRS 16 Lease Accounting — Right-of-Use Asset

IFRS 16 Leases — Core Rule

IFRS 16 Leases requires lessees to recognise a right-of-use (ROU) asset and a lease liability on the balance sheet for virtually all leases. This replaces the former operating/finance lease distinction under IAS 17 and ensures that lease obligations are transparently reflected on the face of financial statements. The standard applies to all leases, with limited exceptions including leases of minerals, biological assets, and service concession arrangements (IFRS 16.3).

Lessees may elect practical exemptions for short-term leases and leases of low-value assets, recognising payments for those leases as an expense on a straight-line basis instead (IFRS 16.5, IFRS 16.6).

How IFRS 16 Leases Works

Identifying a lease (IFRS 16.9): At inception, an entity assesses whether a contract is, or contains, a lease — that is, whether it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. This assessment is only revisited if the contract terms change (IFRS 16.11).

Commencement date recognition (IFRS 16.22): A lessee recognises both a ROU asset and a lease liability at the commencement date. The ROU asset is initially measured at cost (IFRS 16.23), which includes the initial measurement of the lease liability, any lease payments made before commencement less incentives received, initial direct costs, and estimated restoration costs (IFRS 16.24).

Lease liability initial measurement (IFRS 16.26): The lease liability equals the present value of lease payments not yet paid at the commencement date, discounted using the interest rate implicit in the lease or, if that cannot be readily determined, the lessee's incremental borrowing rate.

Lease payments included in the liability (IFRS 16.27): Amounts included in the measurement comprise fixed payments, variable payments linked to an index or rate, amounts under residual value guarantees, and exercise prices of purchase options the lessee is reasonably certain to exercise, as well as early termination penalties where termination is reasonably certain.

Subsequent measurement of the lease liability (IFRS 16.36): After commencement, the lease liability is increased to reflect interest accruing on the outstanding balance, reduced by lease payments made, and remeasured to reflect any reassessments or lease modifications.

Profit or loss (IFRS 16.38): A lessee recognises interest on the lease liability and any variable lease payments not included in the original measurement directly in profit or loss as those payments are triggered.

ROU asset — depreciation and impairment: The ROU asset is depreciated applying IAS 16 principles (IFRS 16.31). If the lease transfers ownership or the lessee is reasonably certain to exercise a purchase option, depreciation runs to the end of the asset's useful life; otherwise it runs to the end of the lease term (IFRS 16.32). The ROU asset must also be tested for impairment under IAS 36 (IFRS 16.33).

Statement of cash flows (IFRS 16.50): Principal repayments on the lease liability are classified within financing activities; interest payments follow IAS 7 requirements; short-term lease payments and low-value lease payments are presented within operating activities.

IFRS 16 Leases — Common Pitfalls

Lease term underestimation: Renewal options must be included in the lease term when the lessee is reasonably certain to exercise them (IFRS 16.18). Ignoring economically compelling renewal options understates both the ROU asset and the lease liability.

Wrong discount rate: Using a rate other than the interest rate implicit in the lease — when that rate can be readily determined — is non-compliant. Only where it cannot be determined may the incremental borrowing rate be used (IFRS 16.26).

Failing to reassess the lease term: A lessee must reassess whether it is reasonably certain to exercise an extension or termination option when a significant event or change in circumstances occurs that is within the lessee's control (IFRS 16.20).

Misclassifying contract components: Each lease component must be accounted for separately from non-lease components unless the lessee elects the practical expedient to combine them (IFRS 16.12). Bundling service and lease elements without proper allocation inflates ROU assets.

Overlooking exemptions: The short-term and low-value exemptions are elective and applied by class of asset (IFRS 16.8). Inconsistent application across similar asset classes is a common compliance gap.

IFRS 16 Leases — Key Paragraphs

IFRS 16.9 — Defines when a contract is, or contains, a lease based on control of an identified asset.
IFRS 16.22 — Requires recognition of both the ROU asset and lease liability at the commencement date.
IFRS 16.26 — Sets out initial measurement of the lease liability at present value, using the implicit rate or incremental borrowing rate.
IFRS 16.24 — Specifies all components of the cost of the ROU asset at initial measurement.
IFRS 16.36 — Governs subsequent measurement of the lease liability, covering interest accretion, repayments, and remeasurement.
IFRS 16.18 — Defines lease term, including reasonably certain extension and termination options.