IFRS - 16 Leases

 

What is lease – Lease is a Contract between owner of the asset and the other party who want to take that asset on rent for use.

What is difference between rent and lease

Simply you can understand that rent is a short-term deal (6-month, 11 Month) and lease is a long term (3 Years, 5 years, 10 years) deal between owner and tenant.

There are two parties In Lease transaction

Lessee – who takes the asset on lease and pays rent payments.

lessor – Who gives the asset on lease and receive rent payments

Example – Company ABC takes a care on lease from XYZ Car Leasing Ltd.

Company ABC – Lessee (ABC will use the asset and pay the rent)

XYZ Car leasing Ltd – Lessor (Owner of the asset, earn rent).

Now we will understand the lease agreement by the example of Rent. But remember if it is short term then it will be rent agreement and if it is for long term agreement then it will be lease.

What happened in Rent agreement one person takes a property on rent he/she pays the rent and use the asset, so he get the right of use but not the ownership of the asset.

Now how to identify it is lease transaction or not

IFRS 16 – Definition of Lease (IFRS16 Para 9)

A lease exists when a contract gives below to customer

1.    The right to control the use of …

2.    An identifies asset …

3.    For a period of time …

4.    In exchange of consideration (Payment)

*** Even a owner adds some protective clauses in the contract, it does not mean that the lessee lost the control.

Accounting process for Lessee

Initial measurement – when you enter in a lease agreement you will get a asset but not owner so we will write it as a Right to use. We will do Debit right to use instead of asset. And we will credit Lease Liability.

Journal Entry

Right to use A/C              Dr.     45000

To Lease Liability            Cr.      40000 (Present Value of all future payments)

To Cash                           Cr.     5000 (Initial Payment)

At the initial stage of lease, the lessee recognises a right to use asset and a lease liability.

Right of Use asset	Lease liability
Measure at the amount of the lease liability plus any initial direct cost incurred by the lessee.	Measured at the present value of lease payments payable over the lease term, discounted at the rate implicit in the lease
Lease Liability          Initial direct cost          Estimated cost for dismantlement         Payments less incentives before commencement date	Fixed payments less incentives Variable payment (E.q CPI/ Rate Consumer per index) Expected residual value guarantee Penalty for terminating (if reasonably Certain) Note: - if the rate implicit in the lease can not be determined. The lessee shall use their incremental borrowing rate.

Subsequent measurement

Right of Use asset	Lease liability
Cost less accumulated depreciation Note:  Depreciation is based on the earlier of the useful life & lease term, unless ownership transfers in which case use of the useful life.	Financial Liability at amortised cost

 

Asset – Depreciation (Asset life – 10 years, lease – 6 years) which ever is shorter

Lease liability – Opening Lease liability + interest (-) payment = closing balance 

Optional Recognition Exemptions

IFRS 16 normally requires lessees to recognise ROU asset & liabilities. But for simplicity, 2 exemptions allowed:

Type	Conditions	Example
Short term	Lease less then or equal 12 month & no purchase option.	Renting a printer for 6 months
Low value	Asset value is low when new (around $5000 or less )	Tables, laptops, office furniture

Why IFRS 16 Was Introduced

Before IFRS 16, companies used to keep many leases off the balance sheet. That made financial statements look stronger than reality.

For example, airlines lease aircraft worth billions, but earlier those obligations were not visible on balance sheets.

Now: Assets increase, Liabilities increase, EBITDA increases, Interest expense increases, Debt ratios change

This gives a more realistic picture of financial position.

Optional Recognition Exemptions

IFRS 16 provides two practical exemptions for lessees:

1. Short-Term Lease

If lease term is 12 months or less and there is no purchase option, companies can expense payments directly.

Example: Renting a printer for 6 months.

2. Low-Value Asset

If the asset value is low when new (around $5,000 or less), recognition of ROU and liability is not required.

Examples: Laptops, Office furniture, Small equipment

These can be treated as normal expense.

Financial Statement Impact

Lease accounting affects:

• Balance Sheet
• Increase in assets (ROU)
• Increase in liabilities (Lease Liability)
• Profit & Loss
• Depreciation expense
• Interest expense

Earlier, lease payments were fully shown as operating expense. Now expense pattern changes.

Practical Understanding

From a business perspective, leasing helps companies:

• Preserve cash
• Avoid large upfront investment
• Use updated assets
• Maintain flexibility
• From an accounting perspective, IFRS 16 ensures:
• Transparency
• Better comparability
• Accurate debt representation

Final Thoughts

Lease accounting may look technical, but the logic is simple:

If you are using an asset for a long time and committing to future payments, that commitment should appear in your financial statements.

You may not own the asset legally, but economically you are controlling it.

That’s why IFRS 16 recognises:

•       Right of Use Asset
•       Lease Liability

Understanding lease accounting is important not only for exams but also for analysing companies properly. Many businesses today depend heavily on leased assets.

When you read financial statements next time, check:

How much lease liability is there?

What is the lease term?

How does it impact cash flow and profit?

Because sometimes, the biggest obligations are hidden in plain sight.

And finance is all about understanding those hidden commitments clearly.

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