IFRS 16 Leases: A Practical Guide for Accountants

What Is IFRS 16?

IFRS 16 Leases replaced IAS 17 and fundamentally changed how lessees account for leases. It applies to annual periods beginning on or after 1 January 2019. Under IFRS 16, lessees no longer distinguish between operating and finance leases — almost all leases are brought onto the balance sheet as a right-of-use (ROU) asset and a corresponding lease liability. This had a transformative impact on the financial statements of businesses with significant leased assets: retailers, airlines, hotel groups, and logistics companies were among the most affected.

The Core Model: Lessee Accounting

On commencement of a lease, the lessee recognises: a right-of-use asset (measured at cost — present value of future lease payments plus initial direct costs plus any lease incentives paid) and a lease liability (present value of future lease payments, discounted at the interest rate implicit in the lease or, if that cannot be determined, the lessee's incremental borrowing rate).

Subsequent Measurement

The ROU asset is depreciated over the shorter of the useful life of the underlying asset and the lease term. The lease liability is unwound using the effective interest method — each payment reduces the liability (principal) and recognises an interest charge. The total charge to profit or loss (depreciation + interest) is higher in early periods and lower later, which is front-loaded compared to the old straight-line operating lease expense.

Practical Exemptions

IFRS 16 allows two practical expedients: short-term leases (lease term 12 months or less) and low-value asset leases (underlying asset value when new below approximately $5,000) can be expensed on a straight-line basis, similar to old IAS 17 operating lease treatment.

Lease Modifications

When lease terms change, the lease liability is remeasured and the ROU asset adjusted. A lease modification that increases the scope of the lease and increases consideration is generally treated as a separate lease. Other modifications adjust the existing liability. This is one of the most complex practical areas of IFRS 16 application.

Lessor Accounting

IFRS 16 made fewer changes for lessors — they still classify leases as finance or operating. Finance leases (where substantially all risks and rewards transfer to the lessee) are recognised as a receivable; operating leases continue to be recognised as income on a straight-line basis.

Key Disclosures

Lessees must disclose: the carrying amount of ROU assets by class, the maturity analysis of lease liabilities, interest expense on lease liabilities, depreciation of ROU assets, short-term and low-value lease expenses, and a qualitative description of the lease portfolio.

Common Practical Challenges

Determining the lease term (including extension and break options), setting the incremental borrowing rate (particularly for groups with multiple entities and currencies), and managing variable lease payments (only include payments where there is a reasonably certain exercise of an option) are the most common areas where judgement is required and auditors focus attention.

Further Reading

• Accounting Standards CPD
• ACCA FR Exam Guide
• ACCA SBR Exam Guide

CPD on IFRS 16

Learnsignal's CPD courses include IFRS 16 implementation and update modules counting as verifiable CPD hours. Explore accounting standards CPD.

FAQ

Does IFRS 16 apply to all leases?

Almost all — the two main exemptions are short-term leases (12 months or less) and low-value asset leases. Leases of intangible assets are also outside scope unless the entity elects to apply IFRS 16 to them.

How do you determine the incremental borrowing rate?

The IBR is the rate the lessee would have to pay to borrow, over a similar term and with similar security, the funds necessary to obtain an asset of similar value to the ROU asset in a similar economic environment. In practice, many companies use their unsecured borrowing rate adjusted for the secured nature of a lease, or apply a simplified approach using observable government bond yields plus a credit spread.