IFRS 16 Leases sets out the principles for recognising, measuring, presenting and disclosing leases, so that lessees and lessors provide information that faithfully represents those transactions (IFRS 16.1). Its core idea is simple: at the commencement date a lessee recognises a right-of-use asset and a lease liability (IFRS 16.22), subject to two optional exemptions (IFRS 16.5). Lessors, by contrast, still classify each lease as a finance lease or an operating lease (IFRS 16.61). The Standard applies to annual reporting periods beginning on or after 1 January 2019 and replaced IAS 17 (IFRS Foundation: IFRS 16).
Scope
IFRS 16 applies to all leases, including leases of right-of-use assets in a sublease, except (IFRS 16.3):
- leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources;
- leases of biological assets within the scope of IAS 41 held by a lessee;
- service concession arrangements within the scope of IFRIC 12;
- licences of intellectual property granted by a lessor within the scope of IFRS 15; and
- rights held by a lessee under licensing agreements within the scope of IAS 38, such as motion picture films, patents and copyrights.
Is the contract a lease?
At inception, an entity assesses whether a contract is, or contains, a lease. It does if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration (IFRS 16.9). The assessment asks three questions (IFRS 16.B9):
| Question | What the Standard requires | Paragraphs |
|---|---|---|
| Is there an identified asset? | Explicitly or implicitly specified. Not identified if the supplier has a substantive substitution right: the practical ability to substitute throughout the period of use and an economic benefit from doing so | B13–B19 |
| Does the customer obtain the benefits? | The right to obtain substantially all of the economic benefits from use of the asset throughout the period of use | B21–B23 |
| Does the customer direct the use? | The right to direct how and for what purpose the asset is used throughout the period of use, or, if those decisions are predetermined, the right to operate the asset or having designed it | B24–B30 |
A capacity portion of an asset is an identified asset if it is physically distinct, such as one floor of a building (IFRS 16.B20). The assessment is redone only if the terms and conditions of the contract change (IFRS 16.11). A lessee separates lease components from non-lease components, or elects, by class of underlying asset, to treat them as a single lease component (IFRS 16.12, 15).
Lease term
The lease term is the non-cancellable period plus periods covered by an extension option the lessee is reasonably certain to exercise, and periods covered by a termination option the lessee is reasonably certain not to exercise (IFRS 16.18). It begins at the commencement date and includes any rent-free periods (IFRS 16.B36).
The assessment considers everything that creates an economic incentive for the lessee: terms of the optional periods compared with market rates, significant leasehold improvements, termination costs and the importance of the asset to the lessee's operations (IFRS 16.B37). The lessee reassesses on a significant event or significant change in circumstances that is within its control (IFRS 16.20).
Initial measurement by the lessee
Lease liability
The lease liability is the present value of the lease payments not paid at the commencement date, discounted at the interest rate implicit in the lease if that rate can be readily determined, or otherwise at the lessee's incremental borrowing rate (IFRS 16.26). That rate is what the lessee would pay to borrow, over a similar term and with similar security, the funds needed to obtain an asset of similar value to the right-of-use asset in a similar economic environment (IFRS 16, Appendix A).
Lease payments comprise (IFRS 16.27):
- fixed payments, including in-substance fixed payments, less lease incentives receivable;
- variable payments that depend on an index or a rate, measured using the index or rate at the commencement date;
- amounts expected to be payable under residual value guarantees;
- the exercise price of a purchase option the lessee is reasonably certain to exercise; and
- termination penalties, if the lease term reflects the lessee exercising a termination option.
Variable payments that do not depend on an index or a rate, such as a percentage of sales, stay out of the liability. They are recognised in profit or loss in the period in which the triggering event occurs (IFRS 16.38).
Right-of-use asset
The right-of-use asset is measured at cost (IFRS 16.23), which comprises (IFRS 16.24):
- the initial measurement of the lease liability;
- lease payments made at or before the commencement date, less lease incentives received;
- initial direct costs incurred by the lessee; and
- an estimate of the costs of dismantling and removing the asset, or restoring the site or the asset as the lease requires.
The two exemptions: short-term and low-value leases
A lessee may elect not to apply the recognition and measurement requirements to short-term leases and to leases of low-value assets (IFRS 16.5). It then recognises the payments as an expense on a straight-line basis over the lease term, or on another systematic basis if that better represents the pattern of its benefit (IFRS 16.6).
- Short-term lease: a lease term of 12 months or less at the commencement date, with no purchase option (IFRS 16, Appendix A). The election is made by class of underlying asset (IFRS 16.8).
- Low-value asset: judged on the asset's value when new, regardless of its age, and on an absolute basis, whatever the lease's materiality to the lessee (IFRS 16.B3–B4). The election can be made lease by lease (IFRS 16.8). Examples include tablet and personal computers, small items of office furniture and telephones (IFRS 16.B8). Cars do not qualify (IFRS 16.B6), nor does a head lease if the lessee subleases, or expects to sublease, the asset (IFRS 16.B7).
Subsequent measurement and presentation by the lessee
Right-of-use asset. Usually measured under the cost model: cost less accumulated depreciation and impairment losses, adjusted for remeasurements of the lease liability (IFRS 16.29–30). It is depreciated under IAS 16 (IFRS 16.31) and tested for impairment under IAS 36 (IFRS 16.33). Depreciation runs to the end of the underlying asset's useful life if ownership transfers or a purchase option is reflected in the cost; otherwise to the earlier of the end of the right-of-use asset's useful life and the end of the lease term (IFRS 16.32). For depreciation methods, see IAS 16 Property, Plant and Equipment.
Lease liability. It increases with interest, decreases with payments and is remeasured for reassessments and modifications (IFRS 16.36). Interest produces a constant periodic rate on the remaining balance (IFRS 16.37).
Remeasurement. The remeasurement amount adjusts the right-of-use asset; once that asset reaches zero, any further reduction goes to profit or loss (IFRS 16.39). A revised discount rate is used when the lease term or the assessment of a purchase option changes (IFRS 16.40–41). The rate stays unchanged when amounts expected under a residual value guarantee change, or payments linked to an index or a rate change, unless the change comes from floating interest rates (IFRS 16.42–43).
Presentation. Interest expense on the lease liability is presented separately from the depreciation charge for the right-of-use asset (IFRS 16.49). In the statement of cash flows, principal repayments are financing activities, interest follows the IAS 7 requirements for interest paid, and short-term, low-value and variable payments not in the liability are operating activities (IFRS 16.50).
Lease modifications
A modification is a separate lease if it adds the right to use one or more underlying assets and the consideration increases by an amount commensurate with the stand-alone price of the increase (IFRS 16.44). Otherwise, the lessee remeasures the liability using a revised discount rate at the effective date of the modification (IFRS 16.45). It adjusts the right-of-use asset by the same amount, or, if the modification reduces the scope of the lease, reduces the asset and recognises a gain or loss (IFRS 16.46).
Lessor accounting: finance or operating?
A lessor classifies each lease as a finance lease or an operating lease (IFRS 16.61). A lease is a finance lease if it transfers substantially all the risks and rewards incidental to ownership; otherwise it is an operating lease (IFRS 16.62). Substance matters more than form. Indicators of a finance lease include transfer of ownership by the end of the term, a lease term covering the major part of the asset's economic life, and lease payments whose present value amounts to substantially all of the asset's fair value (IFRS 16.63). Classification is made at inception and reassessed only on a lease modification (IFRS 16.66).
| Finance lease | Operating lease | |
|---|---|---|
| Statement of financial position | A receivable equal to the net investment in the lease | The underlying asset stays on the books, presented according to its nature |
| Income | Finance income reflecting a constant periodic rate of return on the net investment | Lease income on a straight-line or other systematic basis |
The table draws on IFRS 16 (IFRS 16.67, 75, 81, 88).
Sale and leaseback
When an entity (the seller-lessee) transfers an asset to another entity (the buyer-lessor) and leases it back, specific requirements apply (IFRS 16.98). The first step is to decide whether the transfer is a sale, using the IFRS 15 requirements on satisfying a performance obligation (IFRS 16.99):
- If it is a sale: the seller-lessee measures the right-of-use asset at the proportion of the asset's previous carrying amount that relates to the right of use it retains, so it recognises only the gain or loss on the rights transferred to the buyer-lessor (IFRS 16.100(a)). If the consideration is not at fair value or the lease payments are not at market rates, below-market terms are a prepayment of lease payments and above-market terms are additional financing from the buyer-lessor (IFRS 16.101).
- If it is not a sale: the seller-lessee keeps the asset and recognises a financial liability equal to the transfer proceeds; the buyer-lessor recognises a financial asset. Both apply IFRS 9 (IFRS 16.103).
The 2022 amendment. After the commencement date, the seller-lessee determines "lease payments" or "revised lease payments" so that it recognises no gain or loss relating to the right of use it retains. This does not stop it recognising a gain or loss on the partial or full termination of the lease (IFRS 16.102A). The amendment was issued in September 2022 and applies to annual periods beginning on or after 1 January 2024 (IFRS Foundation: changes in the 2023 edition).
Worked example: a five-year lease
The numbers are illustrative. An entity leases equipment for 5 years at 100,000 a year, paid at the end of each year. The implicit rate cannot be readily determined, so it uses an assumed incremental borrowing rate of 6%. It pays initial direct costs of 5,000 in cash. Ownership does not transfer and there is no purchase option, so the asset is depreciated over the lease term (IFRS 16.32).
- Lease liability = present value of five payments at 6% = 421,236 (IFRS 16.26).
- Right-of-use asset = 421,236 + 5,000 = 426,236 (IFRS 16.24); straight-line depreciation of about 85,247 a year.
Entry at the commencement date:
| Account | Debit | Credit |
|---|---|---|
| Right-of-use asset | 426,236 | |
| Lease liability | 421,236 | |
| Cash (initial direct costs) | 5,000 |
Lease liability schedule (year 5 interest rounded to clear the balance):
| Year | Opening balance | Interest 6% | Payment | Closing balance |
|---|---|---|---|---|
| 1 | 421,236 | 25,274 | 100,000 | 346,510 |
| 2 | 346,510 | 20,791 | 100,000 | 267,301 |
| 3 | 267,301 | 16,038 | 100,000 | 183,339 |
| 4 | 183,339 | 11,000 | 100,000 | 94,339 |
| 5 | 94,339 | 5,661 | 100,000 | 0 |
Year 1 entries (the payment, then depreciation):
| Account | Debit | Credit |
|---|---|---|
| Interest expense | 25,274 | |
| Lease liability | 74,726 | |
| Cash | 100,000 | |
| Depreciation — right-of-use asset | 85,247 | |
| Accumulated depreciation — right-of-use asset | 85,247 |
Year 1 profit or loss bears 110,521 (interest 25,274 plus depreciation 85,247) against a cash payment of 100,000; by year 5 the charge falls to about 90,908. The expense is front-loaded because interest is calculated on a declining balance.
What changed from IAS 17?
- Before IFRS 16: IAS 17 classified leases as finance or operating leases, and lessees expensed operating lease payments on a straight-line basis (IFRS Foundation: IAS 17). Only finance leases appeared on the balance sheet; operating leases were only disclosed in the notes (IFRS Foundation: IFRS 16 project).
- After: IFRS 16, issued in January 2016, replaced IAS 17, IFRIC 4, SIC-15 and SIC-27 with a single lessee model: assets and liabilities for all leases with a term of more than 12 months, unless the underlying asset is of low value (IFRS Foundation: IFRS 16).
- Lessors: classification as finance or operating, based on the transfer of risks and rewards, remains (IFRS 16.61–62).
- Transition: lessees chose between full retrospective application under IAS 8 and recognising the cumulative effect in opening retained earnings without restating comparatives (IFRS 16.C5, C7). Lessors were not required to make transition adjustments, except intermediate lessors (IFRS 16.C14).
What is new in IFRS 16?
- Covid-19-related rent concessions (May 2020, extended March 2021): a practical expedient that let lessees skip assessing whether such a concession was a lease modification (IFRS Foundation: extension news release). It covered only payments originally due on or before 30 June 2022 (IFRS 16.46B), so its effect is now historical.
- Lease liability in a sale and leaseback (September 2022): explained above.
- Derecognition of lease liabilities: Annual Improvements to IFRS Accounting Standards—Volume 11 (July 2024) clarified in the scope of IFRS 9 that a lessee whose lease liability is extinguished applies paragraph 3.3.3 of IFRS 9 and recognises the resulting gain or loss in profit or loss (IFRS Foundation project). It applies for annual periods beginning on or after 1 January 2026.
- IFRS 18 Presentation and Disclosure in Financial Statements: replaces IAS 1 for annual reporting periods beginning on or after 1 January 2027 and makes consequential amendments to IFRS 16 (IFRS Foundation: IFRS 18).
- Post-implementation Review: in July 2026 the International Accounting Standards Board (IASB) concluded that IFRS 16 is overall working as intended and decided to add a research project to its pipeline on reducing lessees' ongoing measurement costs, such as lease liability remeasurements and discount rates (IFRS Foundation: PIR of IFRS 16).
A practical tool
To calculate the liability, its schedule and each period's entries across several leases, use the IFRS 16 Lease Model: Right-of-Use Asset and Lease Liability. For the revenue side of sale and leaseback, see IFRS 15 Revenue from Contracts with Customers.
Sources
- IFRS Foundation: IFRS 16 Leases. References in brackets are to paragraphs of the Standard and its appendices.
- IFRS Foundation: IAS 17 Leases (superseded).
- IFRS Foundation: IFRS 16 Leases project (2016).
- IFRS Foundation: Changes in this edition (2023) and Changes in this edition (2026).
- IFRS Foundation: Annual Improvements—Volume 11: derecognition of lease liabilities.
- IFRS Foundation: Post-implementation Review of IFRS 16 Leases.
- IFRS Foundation: IFRS 18 Presentation and Disclosure in Financial Statements.