Accounting for Leases under IFRS 16: A Complete Guide to Lease Accounting

Lease accounting has become one of the most important areas of financial reporting for businesses that rent offices, warehouses, vehicles, machinery, or equipment. Since the introduction of IFRS 16, organizations must recognize most lease agreements on their balance sheets, providing a clearer and more transparent picture of their financial position.

In 2026, IFRS 16 remains the globally accepted lease accounting standard for businesses that prepare financial statements under IFRS Accounting Standards. Although the International Accounting Standards Board (IASB) continues to review the practical application of the standard through its Post-implementation Review (PIR), the core lease accounting requirements remain unchanged. Businesses must continue to recognize a Right-of-Use (ROU) Asset and a Lease Liability for most leases.

What Is IFRS 16?

IFRS 16 is an accounting standard issued by the International Accounting Standards Board (IASB) that establishes how businesses should recognize, measure, present, and disclose lease transactions in their financial statements.

The standard became effective on 1 January 2019, replacing IAS 17 Leases. It was introduced to improve transparency by ensuring that most lease obligations appear directly on the balance sheet instead of remaining off-balance sheet.

Under IFRS 16, lessees generally recognize two key accounting elements:

• Right-of-Use (ROU) Asset – Represents the right to use a leased asset during the lease term.
• Lease Liability – Represents the obligation to make future lease payments.

This accounting approach provides investors, lenders, regulators, and management with a more accurate understanding of a company’s financial commitments.

Why Was IFRS 16 Introduced?

Before IFRS 16, businesses applied IAS 17, which classified leases as either operating leases or finance leases. Many operating leases were excluded from the balance sheet, making it difficult for stakeholders to evaluate a company’s actual financial obligations.

For example, a company could lease multiple office buildings for several years without reporting the associated liabilities on its balance sheet. Although the company had significant future payment obligations, its financial position appeared stronger than it actually was.

IFRS 16 addressed these shortcomings by introducing a single lessee accounting model that requires most leases to be recognized on the balance sheet.

The standard aims to:

• Improve transparency in financial reporting.
• Increase comparability between businesses.
• Provide investors with more reliable financial information.
• Reflect lease obligations more accurately.
• Support better business and investment decisions.
• Reduce off-balance-sheet financing.

Who Must Apply IFRS 16?

IFRS 16 applies to organizations that prepare financial statements under IFRS Accounting Standards and enter into lease agreements.

Industries commonly affected include:

• Retail
• Manufacturing
• Construction
• Healthcare
• Hospitality
• Logistics and transportation
• Educational institutions
• Real estate companies
• Professional service firms
• Technology companies

Any organization leasing offices, warehouses, company vehicles, IT equipment, production machinery, or commercial property should assess its lease contracts under IFRS 16.

Why Lease Accounting Changed Under IFRS 16

The introduction of IFRS 16 represented one of the most significant accounting changes in recent years because it fundamentally changed how businesses report lease obligations.

Limitations of IAS 17

Under IAS 17, leases were divided into:

• Operating leases
• Finance leases

While finance leases appeared on the balance sheet, operating leases generally remained off the balance sheet. Businesses only recognized lease expenses in the income statement while future payment obligations were disclosed in the notes to the financial statements.

This created several challenges:

• Financial statements lacked transparency.
• Companies with similar lease obligations reported different financial positions.
• Investors struggled to compare businesses accurately.
• Debt ratios often appeared lower than actual obligations.
• Long-term lease commitments were difficult to evaluate.

How IFRS 16 Improves Financial Reporting

IFRS 16 solves these issues by requiring businesses to recognize most lease obligations directly on the balance sheet.

The benefits include:

• Greater transparency for investors and lenders.
• More accurate financial reporting.
• Improved comparability across industries.
• Better visibility of long-term liabilities.
• Stronger corporate governance.
• Enhanced compliance with IFRS Accounting Standards.

As a result, financial statements provide a more complete picture of an organization’s assets, liabilities, and financial performance.

How IFRS 16 Works

Lease accounting under IFRS 16 follows a structured process that helps businesses recognize and measure lease transactions consistently.

Step 1 – Identify a Lease

The first step is determining whether a contract contains a lease.

A contract qualifies as a lease when it:

• Identifies a specific asset.
• Gives the customer the right to control the use of that asset.
• Allows the customer to obtain substantially all economic benefits from using the asset during the lease period.

Examples of leased assets include:

• Office buildings
• Commercial property
• Warehouses
• Company vehicles
• Manufacturing equipment
• Construction machinery
• Computer servers
• Medical equipment

If these conditions are not met, the agreement is generally treated as a service contract rather than a lease.

Step 2 – Recognize the Lease

Once a lease has been identified, the lessee records two items on the commencement date.

Right-of-Use (ROU) Asset

The Right-of-Use Asset represents the lessee’s right to use the leased asset throughout the agreed lease term. The asset is initially recognized at cost and subsequently depreciated over the lease term or the asset’s useful life, depending on the lease arrangement.

Lease Liability

The Lease Liability represents the present value of future lease payments that the lessee is obligated to make under the lease agreement.

Lease payments generally include:

• Fixed lease payments
• Variable lease payments linked to an index or rate
• Amounts payable under residual value guarantees
• Exercise price of purchase options when reasonably certain
• Termination penalties, where applicable

Step 3 – Initial Measurement

At the lease commencement date, businesses calculate the present value of future lease payments.

To determine the present value, the lessee uses:

• The interest rate implicit in the lease, when readily available.
• The incremental borrowing rate if the implicit rate cannot be determined.

The initial cost of the Right-of-Use Asset normally includes:

• Initial Lease Liability
• Lease payments made before commencement
• Initial direct costs
• Estimated restoration or dismantling costs
• Less any lease incentives received

Accurate initial measurement ensures reliable financial reporting throughout the lease term.

Step 4 – Subsequent Measurement

After initial recognition, businesses must update both the Lease Liability and the Right-of-Use Asset throughout the lease period.

The Lease Liability is adjusted by:

• Adding interest expense using the effective interest method.
• Reducing the liability as lease payments are made.
• Reassessing the liability when lease terms or future payments change.

The Right-of-Use Asset is subsequently measured by:

• Recording depreciation.
• Recognizing impairment losses when necessary.
• Adjusting for lease modifications or reassessments.

Regular monitoring helps organizations maintain compliance and ensures financial statements remain accurate year after year.

Key Components of Lease Accounting Under IFRS 16

Understanding the main components of lease accounting makes it easier to apply IFRS 16 correctly and maintain accurate financial records.

Component	Description	Why It Matters
Lease Liability	Present value of future lease payments	Records the company’s contractual lease obligation.
Right-of-Use (ROU) Asset	Asset representing the right to use the leased property or equipment	Appears as a non-current asset on the balance sheet.
Lease Term	Non-cancellable lease period plus renewal options that are reasonably certain	Determines depreciation and liability calculations.
Discount Rate	Interest rate used to calculate the present value of lease payments	Directly affects lease valuation and financial reporting.
Lease Payments	Fixed payments and qualifying variable payments made during the lease	Forms the basis for measuring the lease liability.
Lease Incentives	Benefits received from the lessor, such as rent-free periods or reimbursements	Reduce the initial cost of the Right-of-Use Asset.
Residual Value Guarantee	Amount guaranteed by the lessee at the end of the lease	May increase the lease liability depending on the contract terms.
Lease Modifications	Changes to lease scope, payments, or duration after commencement	Require reassessment and updated accounting entries.

A solid understanding of these components helps businesses comply with IFRS 16, produce reliable financial statements, and reduce the risk of accounting errors. As organizations continue to adopt digital accounting systems in 2026, maintaining an accurate lease register and regularly reviewing lease agreements has become an essential part of effective lease management.

Lessee Accounting Under IFRS 16

One of the most significant changes introduced by IFRS 16 is the accounting treatment for lessees. Instead of classifying most leases as either operating or finance leases, lessees now follow a single accounting model for nearly all lease agreements.

At the lease commencement date, the lessee recognizes:

• A Right-of-Use (ROU) Asset
• A Lease Liability

These two elements remain the foundation of lease accounting under IFRS 16.

Initial Recognition

On the commencement date, the lease liability is measured at the present value of future lease payments, while the Right-of-Use Asset is generally measured at cost.

The initial cost of the Right-of-Use Asset includes:

• Initial lease liability
• Lease payments made before the commencement date
• Initial direct costs
• Estimated dismantling or restoration costs
• Less any lease incentives received

Accurate initial recognition reduces future reporting errors and helps maintain compliance with IFRS Accounting Standards.

Subsequent Accounting

After initial recognition, businesses must update both balances throughout the lease term. The Lease Liability increases due to interest expense and decreases as lease payments are made. The Right-of-Use Asset is depreciated systematically over the lease term unless ownership transfers to the lessee.

Regular reassessment is also required when:

• Lease terms change
• Lease payments are modified
• Renewal options become reasonably certain
• Purchase options are exercised
• Contracts are amended

Keeping lease records updated ensures accurate financial reporting and supports successful audits.

Example of Lessee Accounting

A company leases office space for five years.

• Annual lease payment: $50,000
• Discount rate: 5%
• Present value of lease payments: $216,474 (illustrative)

At the commencement date, the company records:

• Right-of-Use Asset: $216,474
• Lease Liability: $216,474

Each year, the company:

• Records depreciation on the Right-of-Use Asset.
• Recognizes interest expense on the Lease Liability.
• Reduces the liability as lease payments are made.

This method provides a clearer picture of the company’s assets and long-term obligations.

Lessor Accounting Under IFRS 16

Unlike lessee accounting, lessor accounting remains largely unchanged from IAS 17. Lessors continue to classify leases into two categories:

Operating Lease

In an operating lease:

• Ownership risks and rewards remain with the lessor.
• The leased asset stays on the lessor’s balance sheet.
• Rental income is recognized over the lease term.
• Depreciation continues to be recorded by the lessor.

Examples include:

• Office building rentals
• Commercial property leases
• Equipment rentals
• Vehicle leasing businesses

Finance Lease

A finance lease transfers substantially all risks and rewards of ownership to the lessee.

In this case:

• The leased asset is removed from the lessor’s balance sheet.
• A lease receivable is recognized.
• Finance income is recognized over the lease period.

Key Differences Between Lessee and Lessor Accounting

Area	Lessee	Lessor
Accounting model	Single accounting model	Operating and finance lease model
Balance sheet	Recognizes ROU Asset and Lease Liability	Depends on lease classification
Depreciation	Records depreciation	Only for operating leases
Interest recognition	Yes	Finance leases only

Understanding these differences helps both parties account for lease contracts correctly.

Lease Exemptions Under IFRS 16

Although IFRS 16 requires most leases to appear on the balance sheet, it provides practical relief for certain lease arrangements. Businesses may choose not to recognize a Right-of-Use Asset and Lease Liability for qualifying leases.

Short-Term Lease Exemption

A lease qualifies if:

• The lease term is 12 months or less.
• There is no purchase option.
• The business elects to apply the exemption.

Lease payments are recognized as an expense over the lease term.

Low-Value Asset Exemption

Businesses may also apply an exemption for leases involving low-value assets.

Common examples include:

• Laptop computers
• Small office printers
• Mobile phones
• Office furniture
• Small IT equipment

These leases can usually be expensed instead of being recognized on the balance sheet.

Practical Expedients

To simplify implementation, IFRS 16 also allows certain practical expedients.

Examples include:

• Grandfathering previous lease assessments during transition.
• Using a single discount rate for portfolios of similar leases.
• Excluding initial direct costs during transition (where permitted).
• Relying on hindsight when determining the lease term during initial adoption.

Before applying any exemption, businesses should ensure it is appropriate for their specific lease agreements and accounting policies.

Practical Lease Accounting Example

The following example demonstrates how lease accounting works under IFRS 16.

Scenario

ABC Manufacturing leases warehouse space.

Lease details

• Lease term: 5 years
• Annual lease payment: $60,000
• Discount rate: 6%
• No purchase option
• Payments made annually

Step 1: Calculate Lease Liability

The company calculates the present value of future lease payments using the applicable discount rate.

Assume the present value equals:

Lease Liability = $252,742 (illustrative)

Step 2: Recognize the Right-of-Use Asset

Since there are no initial direct costs or lease incentives:

Right-of-Use Asset = $252,742

Step 3: Annual Accounting

Each reporting period, ABC Manufacturing:

• Records depreciation of the Right-of-Use Asset.
• Records interest expense on the lease liability.
• Reduces the lease liability after making annual payments.

This approach reflects both the company’s right to use the warehouse and its obligation to make future payments.

Sample Journal Entries for Lease Accounting

The following journal entries illustrate a typical lease under IFRS 16.

Initial Recognition

Account	Debit	Credit
Right-of-Use Asset	$252,742
Lease Liability		$252,742

Recording Interest Expense

Account	Debit	Credit
Interest Expense	XXXX
Lease Liability		XXXX

Recording Lease Payment

Account	Debit	Credit
Lease Liability	XXXX
Cash		XXXX

Recording Depreciation

Account	Debit	Credit
Depreciation Expense	XXXX
Accumulated Depreciation – Right-of-Use Asset		XXXX

These entries continue throughout the lease term until the lease liability is settled and the Right-of-Use Asset is fully depreciated or derecognized.

How IFRS 16 Affects Financial Statements

Recognizing leases on the balance sheet changes several areas of financial reporting.

Financial Statement	Impact of IFRS 16
Balance Sheet	Assets and liabilities increase because businesses recognize the Right-of-Use Asset and Lease Liability.
Income Statement	Lease expense is replaced by depreciation expense and interest expense.
Cash Flow Statement	Principal lease payments are generally reported as financing activities, while interest payments follow the applicable accounting policy under IFRS.
EBITDA	EBITDA often increases because depreciation and interest replace operating lease expenses.
Debt Ratios	Total liabilities increase, which may affect leverage ratios and loan covenants.
Return on Assets (ROA)	ROA may decrease because total assets increase after recognizing the Right-of-Use Asset.

Financial Reporting Considerations

Businesses should evaluate how IFRS 16 affects:

• Debt-to-equity ratios
• Interest coverage ratios
• Loan agreements
• Financial performance indicators
• Budgeting and forecasting
• Investor communications

Finance teams should also review lease agreements regularly, monitor lease modifications, and maintain complete documentation to support accurate financial reporting and compliance.

Common Lease Accounting Mistakes Businesses Make

Applying IFRS 16 correctly requires careful planning and ongoing monitoring. Even experienced finance teams can make mistakes that lead to inaccurate financial statements, compliance issues, or audit findings.

Here are some of the most common lease accounting errors and how to avoid them.

Misidentifying Lease Contracts

Not every contract is clearly labeled as a lease. Some service agreements include an identified asset and give the customer control over its use, making them embedded leases under IFRS 16.

How to avoid it:

• Review all service and outsourcing contracts.
• Identify whether the agreement grants control over a specific asset.
• Consult accounting professionals when contracts are complex.

Using an Incorrect Lease Term

Businesses sometimes overlook renewal, extension, or termination options when determining the lease term.

How to avoid it:

• Assess whether renewal or termination options are reasonably certain.
• Review lease terms annually.
• Update lease calculations when business circumstances change.

Applying the Wrong Discount Rate

The discount rate has a significant impact on the measurement of lease liabilities. Using an incorrect rate can materially affect financial statements.

How to avoid it:

• Use the interest rate implicit in the lease when available.
• Otherwise, apply the company’s incremental borrowing rate.
• Document the assumptions used to support the chosen rate.

Ignoring Lease Modifications

Lease agreements often change during their term. Rent revisions, lease extensions, and changes in leased space require reassessment under IFRS 16.

How to avoid it:

• Monitor lease amendments throughout the year.
• Recalculate lease liabilities promptly.
• Maintain communication between finance, procurement, and legal teams.

Inadequate Documentation

Incomplete documentation makes audits more difficult and increases compliance risks.

How to avoid it:

• Keep signed lease agreements.
• Maintain calculation worksheets.
• Store supporting documents for discount rates and assumptions.
• Retain records of lease modifications and approvals.

Best Practices for IFRS 16 Compliance

Strong internal controls and consistent processes make lease accounting more accurate and efficient.

Consider implementing the following best practices.

• Maintain a centralized lease register for all lease agreements.
• Review lease contracts before signing to identify accounting implications.
• Update lease information whenever contracts change.
• Perform periodic reconciliation between lease schedules and the general ledger.
• Document all accounting judgments and estimates.
• Train finance and accounting teams on IFRS 16 requirements.
• Use lease accounting software to automate calculations and reporting where appropriate.
• Coordinate with auditors throughout the financial reporting process.
• Review financial statement disclosures before year-end reporting.
• Monitor updates from the IASB to stay informed about future developments.

Following these practices helps businesses improve compliance, reduce manual errors, and streamline financial reporting.

Benefits of Proper Lease Accounting

Effective lease accounting is more than a compliance exercise. It provides valuable financial insights that support better decision-making and long-term business performance.

Improved Financial Transparency

Recognizing lease assets and liabilities gives stakeholders a clearer understanding of the company’s financial position.

More Accurate Financial Reporting

Proper lease accounting reduces reporting errors and ensures financial statements reflect the organization’s actual obligations.

Better Decision-Making

Reliable lease information helps management evaluate future investments, negotiate lease agreements, and plan capital expenditures.

Stronger Compliance

Applying IFRS 16 consistently reduces the risk of regulatory issues, audit adjustments, and financial statement restatements.

Greater Investor and Lender Confidence

Transparent reporting improves credibility with banks, investors, and other stakeholders, making it easier to secure financing and build long-term business relationships.

Efficient Lease Management

Maintaining accurate lease records allows businesses to monitor renewal dates, payment schedules, and contract changes more effectively.

How Professional Accounting Support Can Help

Implementing IFRS 16 can be challenging, particularly for businesses with multiple lease agreements or complex contract terms. Professional accounting support can help you identify lease obligations, calculate Right-of-Use Assets and Lease Liabilities, prepare compliant journal entries, and ensure your financial statements meet the latest IFRS Accounting Standards.

If your business needs assistance with lease accounting, financial reporting, bookkeeping, or IFRS compliance, Ripple Accountants can provide expert guidance tailored to your organization’s needs. Contact Ripple Accountants at +971 52 356 5409 or email info@uaetaxcompliance.ae to learn how experienced professionals can support your accounting and compliance requirements.

FAQ

What is lease accounting under IFRS 16?

Lease accounting under IFRS 16 requires lessees to recognize most lease agreements by recording a Right-of-Use Asset and a Lease Liability on the balance sheet. This approach provides a more complete representation of lease obligations.

What is a Right-of-Use Asset?

A Right-of-Use Asset represents a company’s right to use a leased asset during the lease term. It is initially measured at cost and depreciated over the lease period or the asset’s useful life, depending on the lease arrangement.

What is a Lease Liability?

A Lease Liability is the present value of future lease payments that the lessee is obligated to make under the lease agreement.

Which leases are exempt under IFRS 16?

Businesses may elect exemptions for:

• Short-term leases with a lease term of 12 months or less.
• Leases of low-value assets, such as small office equipment, laptops, or printers.

How does IFRS 16 affect the balance sheet?

IFRS 16 increases both assets and liabilities by recognizing the Right-of-Use Asset and Lease Liability. As a result, businesses present a more accurate picture of their financial commitments.

What is the difference between IAS 17 and IFRS 16?

IAS 17 allowed many operating leases to remain off the balance sheet. IFRS 16 introduced a single lessee accounting model that requires most leases to be recognized on the balance sheet.

How are lease payments measured?

Lease payments are measured using their present value, calculated with the interest rate implicit in the lease or the lessee’s incremental borrowing rate when the implicit rate cannot be determined.

Does IFRS 16 apply to small businesses?

IFRS 16 applies to any organization preparing financial statements under IFRS Accounting Standards, regardless of size. However, the practical impact depends on the number and type of lease agreements the business has.

Final Thoughts

Understanding lease accounting under IFRS 16 is essential for producing accurate financial statements and maintaining compliance with IFRS Accounting Standards. By recognizing Right-of-Use Assets and Lease Liabilities, businesses provide greater transparency to investors, lenders, auditors, and other stakeholders.

Disclaimer: This article is for general informational purposes only and should not be considered accounting, tax, audit, or legal advice. While every effort has been made to ensure accuracy as of 2026, businesses should consult qualified accounting professionals or refer to the