IFRS 16 Leases — Complete Guide for Finance Students

IFRS 16 transformed how leases are accounted for, particularly for lessees. By bringing most leases onto the balance sheet, it changed the financial statements of countless companies and remains one of the more significant accounting standards in practice. This guide explains what IFRS 16 is, its core principle, how lease accounting works under it, and the practical challenges it raises — in clear, plain language for accountants and finance professionals. Always check the current text of the standard and any amendments via the IFRS Foundation or your local adoption, as standards are updated over time. For related reading, see our ACCA SBR guide.

What is IFRS 16?

IFRS 16 is the International Financial Reporting Standard that governs the accounting for leases. It replaced the previous standard, IAS 17, and fundamentally changed lessee accounting. Under the old approach, leases were classified as either finance or operating leases, with operating leases kept off the balance sheet. IFRS 16 largely removed that distinction for lessees, requiring most leases to be recognised on the balance sheet. This was a major change, because it brought significant lease commitments — previously disclosed only in the notes — into the primary financial statements, giving a fuller picture of an entity's assets and obligations.

The core principle

The central idea of IFRS 16 is that, for most leases, a lessee recognises:

• A right-of-use asset — representing its right to use the leased item over the lease term.
• A lease liability — representing its obligation to make the lease payments.

This single lessee accounting model means that, rather than treating operating leases as simple rental expenses, lessees account for them in a way similar to the old finance-lease treatment — recognising an asset and a liability, then depreciating the asset and charging interest on the liability over time. The result is a more complete representation of the resources a company controls and the obligations it owes.

How lease accounting works under IFRS 16

In broad terms, at the start of a lease the lessee measures the lease liability at the present value of the future lease payments, and recognises a right-of-use asset based largely on that amount. Over the lease term, the right-of-use asset is depreciated and the lease liability accrues interest and is reduced as payments are made. This typically front-loads the total expense compared with the old straight-line operating-lease charge. IFRS 16 does provide exemptions, allowing lessees to keep certain short-term leases and leases of low-value items off the balance sheet if they choose. Lessor accounting, by contrast, remained largely similar to the previous approach, retaining a distinction between finance and operating leases.

Practical challenges

Applying IFRS 16 raises several practical challenges. Identifying leases can require judgement — determining whether a contract contains a lease at all. Measuring the liability involves estimates, such as the discount rate to use and the lease term (including whether renewal or termination options will be exercised). Gathering the data on all leases across an organisation can be a significant exercise, especially for entities with many leases. And the impact on the financial statements and metrics — on assets, liabilities, and measures like EBITDA and gearing — needs to be understood and explained. These challenges mean IFRS 16 often requires careful systems, judgement and communication.

Why IFRS 16 matters

IFRS 16 matters because it significantly affects how companies present their financial position and performance. By bringing most leases onto the balance sheet, it gives users of financial statements a more complete and comparable picture of an entity's assets and obligations — addressing long-standing concerns that off-balance-sheet operating leases obscured real commitments. For preparers, it requires robust processes and judgement; for users, it changes how key metrics are interpreted. Understanding IFRS 16 is therefore important for anyone preparing, auditing or analysing financial statements. Always refer to the current standard for the detailed requirements, as these can be amended over time.

Frequently asked questions

What does IFRS 16 cover?

The accounting for leases. It replaced IAS 17 and changed lessee accounting by requiring most leases to be recognised on the balance sheet.

What is the core principle of IFRS 16?

For most leases, a lessee recognises a right-of-use asset and a lease liability — a single lessee model that brings operating leases onto the balance sheet.

Are there exemptions under IFRS 16?

Yes — lessees can choose to keep certain short-term leases and leases of low-value items off the balance sheet. Always check the current standard for the precise criteria.

Why does IFRS 16 matter?

It gives a more complete, comparable picture of an entity's assets and obligations by bringing most leases on balance sheet, affecting financial statements and key metrics.

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