IFRS 16 Leases — Complete Guide for Finance Students
IFRS 16 Leases explained: how lessees account for leases, right-of-use assets, lease liabilities, interest and depreciation, practical expedients, and exam tips for ACCA and CMA students.
What is IFRS 16?
IFRS 16 Leases replaced IAS 17 and fundamentally changed how lessees account for leases. Under the old IAS 17, operating leases were kept off the balance sheet — IFRS 16 requires lessees to bring almost all leases onto the balance sheet as right-of-use (ROU) assets and lease liabilities.
This has significant implications for financial analysis, leverage ratios, and covenant compliance — making it a critical standard for finance and accounting professionals in India and globally.
Key Changes from IAS 17 to IFRS 16
| Aspect | IAS 17 (Old) | IFRS 16 (Current) |
|---|---|---|
| Lessee accounting | Finance/operating distinction | Single lessee model — all leases on balance sheet |
| Balance sheet impact | Operating leases off-balance sheet | ROU asset + lease liability for all leases |
| P&L impact | Operating lease = straight-line rent expense | Depreciation (ROU) + interest (liability) |
| EBITDA impact | Operating lease cost reduces EBITDA | EBITDA increases (rent replaced by D&A + interest) |
Lessee Accounting Under IFRS 16
Initial Recognition
At commencement of lease, lessee recognises:
- Right-of-use (ROU) asset: Present value of lease payments + initial direct costs + restoration costs (IAS 37)
- Lease liability: Present value of future lease payments discounted at the interest rate implicit in the lease (or lessee's incremental borrowing rate if rate not determinable)
Subsequent Measurement
ROU asset: Depreciated on a straight-line basis over the lease term (or useful life of underlying asset if shorter). May be revalued if using revaluation model for that class.
Lease liability: Unwound using the effective interest rate method — interest charged to P&L; lease payments reduce the liability.
Exemptions (Practical Expedients)
- Short-term leases: Lease term ≤ 12 months — can expense on straight-line basis (off-balance sheet)
- Low-value assets: Underlying asset value when new ≤ ~$5,000 — can expense on straight-line basis
Lessor Accounting
IFRS 16 made fewer changes to lessor accounting — lessors still classify leases as finance or operating:
- Finance lease: Substantially all risks and rewards of ownership transferred to lessee → lessor derecognises asset, recognises finance lease receivable
- Operating lease: Risks and rewards retained by lessor → underlying asset remains on balance sheet; lease income recognised on straight-line basis
IFRS 16 in Financial Analysis
IFRS 16 significantly affected key financial ratios for companies with large operating lease portfolios (retailers, airlines, hotel chains):
- Debt-to-equity ratios increased (lease liabilities now on balance sheet)
- EBITDA increased (operating lease rentals replaced by D&A + interest)
- Interest cover ratio worsened (new interest charge on lease liabilities)
- Asset base increased (ROU assets on balance sheet)
Financial analysts must adjust for IFRS 16 when comparing companies across periods or against pre-IFRS 16 benchmarks.
ACCA's FR and SBR papers test IFRS 16 extensively. Prepare with Learnsignal.
Further Reading
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