IFRS 16 Lease Accounting: A Practical Implementation Guide for Preparers and Advisors
What IFRS 16 Changed and Why It Still Matters
IFRS 16 Leases, effective from January 2019, eliminated the distinction between operating and finance leases for lessees. The result was a significant increase in reported assets and liabilities for companies with material lease portfolios — particularly those in retail, aviation, logistics, and real estate.
For CPA firms advising companies on IFRS reporting, IFRS 16 continues to generate implementation complexity. New lease agreements, modifications, remeasurements, discount rate judgements, and the interaction with impairment testing all require ongoing technical attention. This guide covers the practical implementation requirements your firm needs to address.
The Core Model: Right-of-Use Asset and Lease Liability
Under IFRS 16, a lessee recognises a right-of-use (ROU) asset and a corresponding lease liability at the commencement date of a lease. The lease liability is measured at the present value of future lease payments, discounted at the rate implicit in the lease — or, where that rate cannot be readily determined, the lessee's incremental borrowing rate (IBR).
The ROU asset is initially measured at the same amount as the lease liability, adjusted for:
Lease payments made at or before commencement
Lease incentives received
Initial direct costs
Estimated restoration costs (if applicable under IAS 37)
Subsequently, the ROU asset is depreciated over the shorter of the asset's useful life and the lease term, unless the lessee is reasonably certain to exercise a purchase option (in which case depreciation runs over the asset's useful life). The lease liability is unwound using the effective interest method, with lease payments reducing the liability balance.
Determining the Lease Term
The lease term is one of the most judgement-intensive aspects of IFRS 16. The standard requires lessees to assess whether extension or termination options are reasonably certain to be exercised. This assessment must reflect all relevant economic factors including the significance of leasehold improvements, the importance of the underlying asset to the lessee's operations, and the costs of relocation.
The IASB has acknowledged that the assessment of "reasonably certain" requires significant judgement and that practice has varied. IFRS 16 requires entities to revisit the lease term assessment when a significant event or change in circumstances occurs that is within the control of the lessee.
Common implementation issues related to lease term include:
Failing to include renewal options that are economically incentivised by significant leasehold improvements
Inconsistent treatment of similar leases across a portfolio
Not reassessing lease term when key facts change (lease renegotiation, strategic decisions to relocate)
Incremental Borrowing Rate Determination
Where the implicit rate cannot be readily determined (which is typical for most property leases), IFRS 16 requires the IBR. The IBR is the rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the ROU asset in a similar economic environment.
Determining a robust IBR requires consideration of:
The lessee's credit risk at the commencement date
The lease term (short-term rates differ materially from long-term rates)
The currency in which the lease is denominated
The security the lessee could provide (the ROU asset as collateral)
The economic environment in which the lease operates
For groups with multiple subsidiaries leasing in different jurisdictions, IBR determination requires a structured approach that can accommodate currency, entity-level credit risk, and lease-term differences. Ad hoc rate selection is a common audit finding.
Lease Modifications
Lease modifications are changes to the terms and conditions of a lease that were not part of the original contract. IFRS 16 requires careful analysis of whether a modification constitutes a separate lease or a modification of the existing lease.
A modification is a separate lease if it adds the right to use one or more underlying assets and the increase in consideration reflects the standalone price of the added right of use. In all other cases, the lessee remeasures the lease liability using a revised discount rate and adjusts the ROU asset accordingly.
For a modification that is not a separate lease, the accounting depends on whether the modification reduces the scope of the lease. If scope is reduced, the lessee decreases the ROU asset and lease liability and recognises a gain or loss. If scope is not reduced, the lessee remeasures the lease liability and adjusts the ROU asset.
Variable Lease Payments
IFRS 16 includes in the lease liability only those variable payments that depend on an index or rate (such as CPI-linked payments or market rent reviews). Variable payments linked to performance (sales-based rent) are excluded from the lease liability and expensed as incurred.
For CPI-linked leases, IFRS 16 requires remeasurement of the lease liability when there is a change in the index or rate — specifically, when lease payments change as a result of the index or rate change. This means entities with material CPI-linked portfolios face periodic remeasurement obligations that generate income statement volatility.
Interaction with Impairment Testing
IFRS 16 interacts with IAS 36 Impairment of Assets in ways that require careful coordination. Where a cash-generating unit (CGU) includes leased assets, the carrying amount of the CGU for impairment testing purposes includes the ROU asset. The value in use calculation must use pre-tax cash flows that include lease payments (since the IAS 36 discount rate is a pre-tax rate that includes the cost of all financing).
This can create circularity where the lease liability affects both the CGU carrying amount and the cash flows used in value in use. Consistent methodology and documented assumptions are essential.
Disclosure Requirements
IFRS 16 requires substantial disclosures that give financial statement users the ability to assess the effect of leases on the entity's financial position, financial performance, and cash flows. Key disclosures include:
Depreciation charge for ROU assets by class of underlying asset
Interest expense on lease liabilities
Short-term lease expense, low-value asset lease expense, and variable lease expense
Maturity analysis of lease liabilities
Total cash outflow for leases (including principal and interest)
Additions to ROU assets
Carrying amount of ROU assets at the end of the period by class of underlying asset
Regulators have noted that disclosures in this area are frequently insufficient. In particular, entities often fail to disclose the nature of lease portfolios, judgements applied to extension options, and the basis on which IBRs have been determined.
IFRS 16 for Lessors
While the lessee model changed significantly under IFRS 16, the lessor model remains substantially unchanged from IAS 17. Lessors continue to classify leases as either finance leases or operating leases based on whether substantially all the risks and rewards of ownership are transferred. For finance leases, the lessor derecognises the underlying asset and recognises a finance lease receivable. For operating leases, the underlying asset remains on the lessor's balance sheet.
The main change for lessors relates to sublease accounting. Where an intermediate lessor subleases an asset, the sublease must be classified with reference to the ROU asset arising from the head lease (not the underlying physical asset).
How Adil Habib Consulting Supports IFRS 16 Implementation
We provide technical IFRS 16 support to CPA firms and their clients, including lease accounting policy development, IBR determination frameworks, lease modification analysis, and disclosure review. Our background includes Big 4 advisory experience across multiple IFRS adoption and restatement projects.
If your firm is supporting a client with IFRS 16 adoption, a significant lease portfolio change, or a regulatory query on lease accounting, contact us to discuss how we can support the engagement on a technical advisory basis.
