IFRS 16 leases overview

Under IFRS 16 a lessee recognises almost every lease on its balance sheet: a right of use asset and a lease liability measured at the present value of the lease payments. Rent disappears from operating costs and is replaced by depreciation and interest, so EBITDA and operating profit rise while reported debt and gearing go up. Only short term leases and leases of low value assets can be kept off the balance sheet.

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What did IFRS 16 change for lessees?

IFRS 16 was issued in January 2016 and applies to annual periods beginning on or after 1 January 2019. It replaced IAS 17, under which lessees split leases into finance leases, on the balance sheet, and operating leases, which were not. IFRS 16 removes that split for lessees and introduces a single model: assets and liabilities for all leases with a term of more than 12 months unless the underlying asset is of low value, with depreciation shown separately from interest. Lessor accounting is substantially carried forward from IAS 17; see our guide to lessor accounting.

HMRC’s Business Leasing Manual at BLM17005 notes that IFRS 16 is mandatory for entities reporting under IFRS and FRS 101 for periods beginning on or after 1 January 2019, and that the revised FRS 102 Section 20 brings a similar model to FRS 102 reporters for periods beginning on or after 1 January 2026. The UK GAAP changes are covered in our guide to FRS 102 changes from January 2026.

How do you tell whether a contract contains a lease?

IFRS 16 paragraph 9 defines a lease as a contract that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. Paragraph B9 requires the customer to have both the right to obtain substantially all of the economic benefits from use of the asset and the right to direct its use. An asset is usually identified by being specified in the contract, but it can also be implicitly specified when it is made available for use (B13).

The assessment is made at inception and repeated only if the terms change (paragraph 11). Leases hidden inside service contracts, such as dedicated vehicles in a logistics deal or a specific floor of a data centre, are a common source of missed liabilities. Where a contract combines a lease with services, the lessee separates the components (paragraph 12), although paragraph 15 allows it, by class of asset, to treat the whole contract as a lease. The services themselves stay off the balance sheet.

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Which leases can stay off the balance sheet?

Paragraph 5 allows a lessee to elect not to apply the balance sheet model to:

Short term leases, with a lease term of 12 months or less at commencement. A lease containing a purchase option is never short term. The election is made by class of underlying asset (paragraph 8).
Leases of low value assets, elected lease by lease. The standard sets no figure. Paragraph B8 gives tablet and personal computers, small items of office furniture and telephones as examples, and the IASB’s effects analysis referred to assets with a new value in the order of 5,000 US dollars or less when IFRS 16 was issued.

Payments under exempt leases are expensed, normally on a straight line basis. Our guide to short term and low value lease exemptions goes through the edge cases.

How are the liability and the right of use asset measured?

At commencement the lease liability is the present value of lease payments not yet paid, discounted at the interest rate implicit in the lease or, if that cannot be readily determined, the lessee’s incremental borrowing rate (paragraphs 26 and 27). The payments include fixed payments less incentives receivable, payments linked to an index or rate measured at the commencement rate, expected residual value guarantee amounts, a purchase option price if exercise is reasonably certain, and termination penalties if the lease term assumes termination. Payments linked to future sales or usage are excluded.

The lease term includes optional extension periods only where the lessee is reasonably certain to extend. The right of use asset starts at the amount of the liability, plus payments made at or before commencement less incentives received, initial direct costs, and estimated dismantling or restoration costs (paragraphs 23 and 24).

What happens after the first day?

The asset is normally held at cost less depreciation and impairment, applying IAS 16 and IAS 36 (paragraphs 29 to 35). The liability increases with interest and falls with payments (paragraphs 36 to 42). It is remeasured, with a matching adjustment to the asset, when the lease term changes, the purchase option assessment changes, the expected residual value guarantee changes, or an index or rate change alters payments.

Depreciation is usually even, but interest falls as the liability is paid down, so the total charge is higher than the old straight line rent in the early years of a lease and lower later. For a portfolio of leases starting and ending at different times the IASB expected the difference to be small.

How does IFRS 16 affect EBITDA, profit, gearing and cash flow?

The IASB’s January 2016 effects analysis set out the expected effect on common metrics for a company with material leases previously off balance sheet:

Metric	Expected effect	Why
EBITDA	Increase	Lease costs move out of operating expenses into depreciation and interest
Operating profit (EBIT)	Increase	The interest element is now a finance cost
Gearing (liabilities to equity)	Increase	Lease liabilities are added to financial liabilities
Current ratio	Decrease	Current lease liabilities increase while current assets do not
Asset turnover	Decrease	Right of use assets add to total assets
Interest cover (EBITDA to interest)	Depends	Both EBITDA and interest increase

Total cash flow does not change, but presentation does. Principal repayments are classified in financing activities and interest follows the entity’s policy for interest paid, so operating cash flow rises and financing outflows rise by the same amount.

What does a worked example look like?

Illustration only. A company leases a warehouse for five years at 100,000 pounds a year, paid in arrears, with no options. The implicit rate is not known and its incremental borrowing rate is 5 per cent.

Lease liability and right of use asset at commencement: 432,948 (100,000 discounted over five years at 5 per cent).
Year 1 charge: depreciation 86,590 plus interest 21,647, a total of 108,237, compared with rent of 100,000 under the old operating lease treatment.
Year 5 charge: depreciation 86,590 plus interest 4,762, a total of 91,351.
EBITDA is 100,000 higher in every year, because none of the lease cost sits above depreciation.
Liability at the end of year 1: 354,595, which counts as debt in a gearing calculation based on the balance sheet.

What about loan covenants and tax?

The effects analysis noted that IFRS does not define EBITDA or debt, and that many loan agreements use definitions independent of IFRS or freeze the accounting rules at the date the facility was signed. Lenders and borrowers should still check covenant definitions, because a covenant tied directly to reported figures can be affected by the change.

For tax, HMRC points readers of its lease accounting pages to the BLM50000 chapter of the Business Leasing Manual, which covers accounts prepared under IFRS 16 and the revised FRS 102.

What mistakes come up most often?

Missing leases embedded in supply or outsourcing contracts.
Setting the lease term at the non cancellable period when an extension is reasonably certain, or the reverse.
Applying the low value exemption to assets far removed from the IFRS 16 examples, such as vehicles, which the revised FRS 102 expressly lists as not low value.
Not remeasuring the liability when a rent review linked to an index changes payments.
Showing principal repayments in operating cash flows.
Comparing EBITDA across periods or companies without adjusting for lease accounting.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.