Last reviewed: August 2026.
IFRS 16 Leases brings most leases onto a lessee’s statement of financial position. Instead of recording only a rental expense, a lessee generally recognises a right-of-use asset and a lease liability, then records depreciation and interest over the lease term.
This guide explains the lessee model, the main journal entries and a complete worked example. It focuses on the accounting mechanics that students, preparers and reviewers need most often.
IFRS 16 lease accounting at a glance
| Stage | Lease liability | Right-of-use asset |
|---|---|---|
| Commencement | Present value of unpaid lease payments. | Liability adjusted for prepayments, incentives, initial direct costs and restoration obligations. |
| After commencement | Increase for interest, reduce for payments and remeasure when required. | Depreciate, test for impairment and adjust for qualifying remeasurements. |
| Profit or loss | Interest expense. | Depreciation and any impairment loss. |
The IFRS Foundation’s IFRS 16 overview describes the same single lessee model: leases longer than 12 months are generally recognised as assets and liabilities unless the underlying asset is of low value.
Scope and optional recognition exemptions
A lessee applies IFRS 16 to a contract that contains a lease, subject to the Standard’s scope exclusions. Two optional recognition exemptions are especially important:
- Short-term leases: the lease term is 12 months or less at commencement and the lease contains no purchase option.
- Leases of low-value assets: the assessment is based on the value of the underlying asset when new. Examples may include small office equipment, but the conclusion depends on the asset and facts.
When an exemption is elected, lease payments are generally recognised as an expense on a straight-line basis, or another systematic basis if that better represents the pattern of benefit. The short-term election is made by class of underlying asset; the low-value election may be made lease by lease.
Does the contract contain a lease?
A contract contains a lease when it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The customer must obtain substantially all economic benefits from use and have the right to direct how and for what purpose the asset is used.
A physically distinct asset can be identified explicitly or implicitly. A supplier’s substantive substitution right may mean there is no identified asset. This control test prevents a service contract from being treated as a lease merely because an asset is used to provide the service.
Initial measurement of the lease liability
At the commencement date, the lease liability equals the present value of lease payments not yet paid. Discount the payments using the interest rate implicit in the lease when that rate can be readily determined; otherwise use the lessee’s incremental borrowing rate.
Payments normally included
- Fixed payments, including in-substance fixed payments, less lease incentives receivable.
- Variable payments that depend on an index or a rate, initially measured using the index or rate at commencement.
- Amounts expected to be payable under residual value guarantees.
- The exercise price of a purchase option when exercise is reasonably certain.
- Termination penalties when the lease term reflects exercise of a termination option.
Payments normally excluded
Usage- or performance-based variable lease payments that do not depend on an index or rate are generally excluded from the initial liability and recognised in profit or loss when the event or condition triggering the payment occurs.
Initial measurement of the right-of-use asset
The initial cost of the right-of-use asset is commonly summarised as:
Lease liability + payments made at or before commencement − incentives received + initial direct costs + estimated dismantling, removal or restoration costs.
This measurement links the asset to the obligation while capturing other directly attributable costs. Restoration obligations are measured under the relevant requirements for provisions, while later impairment is considered under IAS 36.
Journal entry at lease commencement
The core commencement entry is:
Dr Right-of-use asset
Cr Lease liability
Cr Cash / payable, for initial direct costs or payments made at commencement, where applicable
The amounts are not always equal because prepayments, incentives, direct costs and restoration obligations affect the asset but not necessarily the initial lease liability.
Subsequent measurement and journal entries
Lease liability
After commencement, the lessee increases the liability for interest, reduces it for lease payments and remeasures it when specified changes occur. A typical payment-period entry is:
Dr Interest expense
Cr Lease liability
Dr Lease liability
Cr Cash
Right-of-use asset
The right-of-use asset is normally depreciated from the commencement date. If ownership transfers by the end of the lease term, or a purchase option is reasonably certain to be exercised, depreciation generally follows the asset’s useful life. Otherwise, depreciate over the shorter of the useful life and lease term.
Dr Depreciation expense
Cr Accumulated depreciation — right-of-use asset
Worked IFRS 16 lessee example
Facts
On 1 January, a company leases equipment for three years. It pays CU12,000 at the end of each year. The discount rate is 5%. There is no purchase option, residual value guarantee, lease incentive or restoration obligation. Initial direct costs paid at commencement are CU1,000. Assume straight-line depreciation and no impairment.
Calculate the opening liability and asset
The present value of three end-of-year payments is:
CU12,000 × [1 − (1.05)−3] ÷ 0.05 = CU32,679 (rounded).
The opening right-of-use asset is CU33,679: the CU32,679 liability plus CU1,000 initial direct costs. Annual depreciation is CU11,226, calculated as CU33,679 ÷ 3, rounded.
Lease liability amortisation schedule
| Year | Opening liability | Interest 5% | Payment | Closing liability |
|---|---|---|---|---|
| 1 | 32,679 | 1,634 | (12,000) | 22,313 |
| 2 | 22,313 | 1,116 | (12,000) | 11,429 |
| 3 | 11,429 | 571 | (12,000) | — |
Small rounding differences are cleared in the final period. A spreadsheet should calculate with unrounded amounts even when the published schedule displays whole currency units.
Entries for the example
At commencement:
- Dr Right-of-use asset CU33,679
- Cr Lease liability CU32,679
- Cr Cash CU1,000
At the end of Year 1:
- Dr Interest expense CU1,634; Cr Lease liability CU1,634.
- Dr Lease liability CU12,000; Cr Cash CU12,000.
- Dr Depreciation expense CU11,226; Cr Accumulated depreciation CU11,226.
The separate interest and depreciation pattern differs from recording one straight-line rental expense. This is why analysts should consider lease accounting when comparing margins, finance costs and leverage.
Remeasurements and lease modifications
A lease liability may be remeasured for changes such as a revised lease term, a changed assessment of a purchase option, or changed payments resulting from an index or rate. The applicable discount rate depends on the reason for remeasurement. The corresponding adjustment is generally made to the right-of-use asset; if that asset has already been reduced to zero, a further reduction may enter profit or loss.
A modification that adds the right to use one or more underlying assets at a commensurate stand-alone price is accounted for as a separate lease. Other modifications require remeasurement, and a decrease in scope can create a gain or loss. The IFRS Foundation provides dedicated IFRS 16 supporting material for complex application questions.
Presentation and cash-flow effects
| Statement | Typical lessee presentation |
|---|---|
| Financial position | Right-of-use assets and lease liabilities are presented separately or disclosed in the notes; liabilities are split current/non-current as applicable. |
| Profit or loss | Depreciation is separate from interest expense. |
| Cash flows | Principal payments are financing cash flows. Interest follows the entity’s IAS 7 classification policy. Payments for exempt leases and variable payments excluded from the liability are generally operating cash flows. |
For the broader presentation context, see the complete set and purpose of financial statements and the site’s guide to IFRS 18 presentation and disclosure changes.
Disclosure and control checklist
- Reconcile additions, depreciation, impairment and closing right-of-use assets by class.
- Disclose interest expense and expenses for short-term, low-value and relevant variable lease payments.
- Provide a maturity analysis of lease liabilities and qualitative information about significant leasing activities and risks.
- Maintain a complete lease population and clear controls over new contracts, renewals, options, modifications, indices and discount rates.
- Reconcile the lease subledger to the general ledger and review current/non-current classification.
Changes in estimates, judgements and contract terms should also be assessed consistently with the principles in accounting policies, estimates and errors.
Sale and leaseback: current IFRS 16 point
Sale-and-leaseback accounting first considers whether the transfer qualifies as a sale under IFRS 15. The IASB’s 2022 amendment, Lease Liability in a Sale and Leaseback, added subsequent measurement requirements so that a seller-lessee does not recognise a gain or loss relating to the retained right of use. The amendment does not change accounting for leases unrelated to sale-and-leaseback transactions. See the official completed-project page.
Common IFRS 16 mistakes
- Treating every contract that uses an asset as a lease without testing identified asset and control.
- Using undiscounted payments as the opening liability.
- Including all variable payments even when they are based only on future usage or performance.
- Ignoring lease incentives, initial direct costs or restoration obligations when measuring the asset.
- Depreciating the right-of-use asset over the wrong period.
- Failing to remeasure after changes to lease term, options, indices or contract scope.
- Posting the whole cash payment as interest or expense instead of splitting principal and interest.
Key takeaway
For a lessee, IFRS 16 usually begins with two balances: a lease liability equal to the present value of unpaid lease payments and a right-of-use asset adjusted for related commencement items. After commencement, the liability follows the effective-interest method while the asset is depreciated and tested for impairment. A reliable lease schedule, supported by contract controls and reviewed assumptions, is essential for accurate entries and disclosures.
Free IFRS quick reference
Use the IFRS Concepts & Policies Quick Reference to review core recognition, measurement and presentation principles.