What is IFRS 16?
IFRS 16 – Leases is an International Financial Reporting Standard issued by the IASB (International Accounting Standards Board) that provides guidance on accounting for leases. It came into effect on 1 January 2019, replacing the older standard, IAS 17 Leases.
The main purpose of IFRS 16 is to make lease obligations more transparent by putting them on the balance sheet, helping investors and stakeholders better understand a company’s true financial position.
Why Was IFRS 16 Introduced?
Under the old standard, IAS 17, many lease liabilities were kept off the balance sheet, especially operating leases. This allowed companies to hide obligations, which wasn’t ideal for transparency.
With IFRS 16:
- Lessees must recognize a lease liability and a right-of-use (ROU) asset.
- It improves comparability between companies that borrow to buy assets and those that lease them.
- It promotes greater clarity for investors and regulators.
Scope of IFRS 16
IFRS 16 applies to all leases, except:
- Leases to explore for minerals, oil, natural gas
- Biological assets (like forests, crops)
- Licenses of intellectual property under IFRS 15
- Service concession arrangements
- Leases of non-regenerative resources like water
If you’re dealing with any other type of lease – cars, buildings, equipment – IFRS 16 most likely applies.
Key Terms Explained
To understand IFRS 16, you must know some basic terms:
- Lease: A contract that gives the right to use an asset for a period of time in exchange for payment.
- Right-of-Use Asset: The lessee’s right to use the leased asset.
- Lease Liability: The obligation to make future lease payments.
- Incremental Borrowing Rate: The interest rate the lessee would pay to borrow the money to obtain the asset.
What Does Not Fall Under IFRS 16?
While IFRS 16 covers a wide range of leases, some exceptions exist:
- Short-term leases (12 months or less) with no purchase option.
- Leases of low-value assets, such as tablets, small printers, and office furniture.
- Intangible asset leases (like software) may fall under different IFRS rules.
- Leases with variable payments only (e.g., percentage of sales) may be exempted.
In these cases, lessees may choose to not apply full IFRS 16 treatment.
Recognition and Measurement – Lessee Side
Under IFRS 16, when a lease starts, the lessee must:
- Recognize a lease liability for lease payments (discounted to present value).
- Recognize a right-of-use asset equal to the lease liability (plus initial direct costs).
Example:
Company ABC leases office space for 3 years at $10,000/year. The interest rate is 5%.
- Lease Liability: Present value of $10,000 × 3 years = $27,231 (approx.)
- Right-of-Use Asset: $27,231 + any upfront costs
Depreciation and Interest:
Each year, the ROU asset is depreciated, and interest expense is recorded on the lease liability. This is very similar to finance lease accounting under IAS 17.
Recognition and Measurement – Lessor Side
For lessors, nothing changes much from IAS 17.
Leases are still classified as:
- Finance Lease – when substantially all risks/rewards transfer
- Operating Lease – asset remains on the lessor’s books
Lessor’s Accounting:
- In finance lease, recognize lease receivable and derecognize asset.
- In operating lease, continue to recognize asset, and record lease income straight-line.
Practical Tips for Students and Learners
Learning IFRS 16 can be tough. Here’s how to make it easier:
- Break it down – Start by understanding the difference between lessee and lessor.
- Use examples – Always try solving one or two questions after reading.
- Practice calculations – Like lease liability and ROU asset using PV formulas.
- Refer to your exam kit – ACCA, ICAEW, or CA exams test IFRS 16 regularly.
- Watch short videos – Sometimes 5-minute tutorials help much more.
Common Mistakes to Avoid in IFRS 16
Many students and even professionals make the following mistakes:
🔹 1. Ignoring Exemptions
Not all leases require full treatment. Short-term and low-value leases can be exempt.
🔹 2. Confusing Old and New Rules
Don’t apply IAS 17 rules to lessee accounting under IFRS 16.
🔹 3. Wrong Discount Rate
Always use the interest rate implicit in the lease or the incremental borrowing rate.
🔹 4. Not Adjusting for Modifications
Lease changes (like rent increases or time extensions) must be reassessed.
Tools to Help You Master IFRS 16
Here are some resources that can make your learning easier:
- ✅ Excel lease calculators – to practice liability/asset entries.
- ✅ ACCA Learning Hub & BPP materials – especially SBR & FR exams.
- ✅ Official IFRS website – for real-life application updates.
Still Confused? Don’t Worry!
IFRS 16 is detailed and tricky, but it becomes easier with time and practice. Many students think it’s hard and it is but it’s also one of the most rewarding areas if you learn it well. Real accounting jobs often involve lease adjustments, so it’s worth it!
Understanding IFRS 16 is not only important for exams like ACCA, CA, ICAEW, or CPA, but also for working professionals. It helps you think like a real-world accountant and improves your confidence.
We created this guide after deep research and effort, not just to explain IFRS 16, but to help you truly understand it in a clear, simple way.
YOU CAN ALSO VISIT >>>> IFRS 15 Simplified: 5-Step Model, Examples