IFRS 16 Leases: A Practical Guide for Accountants

IFRS 16 Leases is the accounting standard that transformed how companies account for the leases they take out. By bringing most leases onto the balance sheet, it was one of the biggest changes to financial reporting in recent years. This practical guide explains what IFRS 16 covers, the single lessee model it introduced, how leases are measured, the exemptions, and why it matters — in clear, plain language. It's a core financial-reporting topic, relevant to ACCA study. (Always refer to the standard for authoritative requirements.)

What is IFRS 16?

IFRS 16 sets out how to account for leases. It replaced the previous standard, IAS 17, and is effective for annual reporting periods beginning on or after 1 January 2019. Its headline change was to the accounting by lessees (those who lease assets): IFRS 16 requires nearly all leases to be recognised on the balance sheet, ending the previous practice of keeping many leases off it.

The big change: a single lessee model

Under the old IAS 17, lessees split leases into two types: finance leases (on the balance sheet) and operating leases (off the balance sheet, with payments simply expensed). This meant large lease commitments — for shops, aircraft, equipment — could be invisible on the balance sheet, understating a company's effective borrowings. IFRS 16 removed this distinction for lessees, introducing a single model under which a lessee recognises, for almost every lease:

• A right-of-use (ROU) asset — representing its right to use the leased asset; and
• A lease liability — representing its obligation to make the future lease payments.

This brought a huge volume of previously off-balance-sheet obligations onto companies' balance sheets, making their true level of commitments far more visible to investors and lenders.

How leases are measured

At the start of the lease, the lessee measures:

• The lease liability at the present value of the future lease payments, discounted at the rate implicit in the lease (or the lessee's incremental borrowing rate).
• The right-of-use asset at an amount based on the lease liability, plus initial direct costs, prepayments and any estimated dismantling/restoration costs.

Subsequently, the lessee depreciates the right-of-use asset (usually on a straight-line basis) and charges interest on the lease liability, which unwinds as payments are made. So instead of a single rental expense, the income statement now shows depreciation plus interest — which also front-loads the total expense compared with the old straight-line operating-lease charge.

The exemptions

To avoid disproportionate effort for minor leases, IFRS 16 provides two optional exemptions for lessees. Leases that are short-term (12 months or less) and leases of low-value assets (such as small items of equipment) can be kept off the balance sheet, with the payments simply expensed on a straight-line basis — much like the old operating-lease treatment.

Lessor accounting

It's worth noting that IFRS 16 largely retained the previous approach for lessors (those who own and lease out assets). Lessors still classify leases as finance or operating leases and account for them broadly as before. The revolution was on the lessee side.

Why IFRS 16 matters

IFRS 16 matters because it dramatically improved the transparency of companies' lease commitments. Before it, two similar companies could look very different simply because one bought its assets (showing debt) while another leased them (showing nothing on the balance sheet). By putting leases on the balance sheet, IFRS 16 made comparisons fairer and a company's real obligations clearer — affecting key measures like gearing and EBITDA. For accountants, it's a major and heavily-examined standard, and a clear example of how reporting evolves to reflect the true underlying economic substance.

Key practical points on IFRS 16

IFRS 16 changed lease accounting significantly for lessees by bringing most leases onto the balance sheet as a right-of-use asset and a corresponding lease liability, largely removing the old distinction between operating and finance leases. In practice this affects key metrics such as gearing and EBITDA, requires careful identification of what counts as a lease, and involves judgement around discount rates and lease terms. Lessor accounting was less affected. As always, apply the current standard and consider the specific facts of each arrangement.

Frequently asked questions

What is IFRS 16?

The standard on Leases, replacing IAS 17, which requires lessees to recognise nearly all leases on the balance sheet as a right-of-use asset and a corresponding lease liability.

What changed for lessees?

The old operating-vs-finance-lease split was removed. Lessees now use a single model, recognising a right-of-use asset and lease liability for almost all leases, instead of keeping operating leases off balance sheet.

How is a lease measured?

The lease liability is the present value of future lease payments; the right-of-use asset is based on that liability plus certain costs. The asset is then depreciated and interest is charged on the liability as it unwinds.

Are there any exemptions?

Yes — optional exemptions for short-term leases (12 months or less) and leases of low-value assets, which can be kept off the balance sheet with payments expensed on a straight-line basis instead.

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