Understanding IFRS 16 leases is crucial because this accounting standard changed how leases appear in financial statements, requiring most to be recorded on the balance sheet. In this blog, we’ll simplify accounting for leases IFRS 16, explain key IFRS 16 journal entries, and highlight how IFRS 16 accounting impact ratios are affected.
IFRS 16 Leases Demystified: Key Accounting Implications Explained
What is IFRS 16?
IFRS 16 leases is an international accounting standard issued by the IASB (International Accounting Standards Board). It came into effect on January 1, 2019, and replaced IAS 17 Leases.
Under IAS 17, leases were split into:
- Finance leases (appeared on the balance sheet)
- Operating leases (hidden off the balance sheet)
This made it hard to compare companies because some had lease commitments not shown as debt.
IFRS 16 explained: Now, almost all leases must appear on the balance sheet as:
- Right-of-use asset – the value of the item you are leasing
- Lease liability – the amount you owe for the lease payments
This rule applies globally. In Australia, it is called lease accounting AASB 16, but the requirements are almost identical to IFRS 16 leases.
Which Agreements Count as Leases?
Not every contract with payments is a lease under IFRS 16 leases. To be a lease:
- There must be an identifiable asset (e.g., a specific office space, machine, or vehicle).
- You must have the right to control how the asset is used during the lease term.
- You must get most of the benefits from using that asset.
Example:
- Renting a car for three years? Yes, it’s a lease under IFRS 16 explained.
- Paying for a taxi ride? No, because you don’t control the taxi—it’s a service.
Key Steps in Accounting for Leases IFRS 16
Here’s a step-by-step process to handle accounting for leases IFRS 16:
Step 1: Identify the Lease
Check if the contract meets the definition under IFRS 16 leases.
Step 2: Separate Lease and Non-Lease Components
If your contract includes services (like cleaning or maintenance), separate those costs from the lease payments.
Step 3: Calculate the Lease Liability
The lease liability is the present value of future lease payments. This uses a discount rate, which is usually your company’s borrowing rate.
Step 4: Record the Right-of-Use Asset
This is the same value as the lease liability, plus any initial costs.
Step 5: Make Regular IFRS 16 Journal Entries
Each period, you record:
- Depreciation of the right-of-use asset
- Interest on the lease liability
IFRS 16 Journal Entries – Example
Let’s say you lease an office for 3 years. Lease payments are $10,000 per year, and the present value is $27,500.
Stage | Debit | Credit | Amount ($) |
Start of Lease | Right-of-use asset | Lease liability | 27,500 |
Each Year – Depreciation | Depreciation expense | Right-of-use asset | 9,167 |
Each Year – Interest | Interest expense | Lease liability | 1,375 |
Each Year – Payment | Lease liability | Bank | 10,000 |
By following these IFRS 16 journal entries, your balance sheet and income statement reflect the true cost of leasing
How IFRS 16 Changes Financial Ratios
One of the most important parts of IFRS 16 leases is the effect on IFRS 16 accounting impact ratios.
1. EBITDA (Earnings Before Interest, Tax, Depreciation, and Amortization)
Under IFRS 16 explained, rent expense is removed and replaced by depreciation + interest. This increases EBITDA.
2. Debt-to-Equity Ratio
Lease liabilities increase your debt, so this ratio goes up.
3. Return on Assets (ROA)
Because you now have more assets (right-of-use assets), ROA can decrease.
4. Leverage Ratios
Higher debt means higher leverage ratios, affecting how lenders view your risk.
These IFRS 16 accounting impact ratios are important for companies with big leasing costs—like airlines, retail chains, and logistics businesses.
IFRS 16 and AASB 16 – Are They the Same?
Yes, lease accounting AASB 16 in Australia follows the same main rules as IFRS 16 leases. If you understand accounting for leases IFRS 16, you can apply it to AASB 16 with only minor local differences.
Benefits of IFRS 16 Leases
- Greater transparency for investors
- Better comparability between companies
- Clear view of a company’s financial commitments
Challenges in Applying IFRS 16
- Gathering all lease data across different locations
- Calculating the present value for long-term leases
- Changing systems to handle IFRS 16 journal entries
Explaining changes in IFRS 16 accounting impact ratios to stakeholders
Final Thoughts
IFRS 16 leases changed the way companies record and report leases. Now, nearly all leases go on the balance sheet as both assets and liabilities. This improves transparency but also affects financial results and key metrics. Understanding accounting for leases IFRS 16, creating correct IFRS 16 journal entries, and tracking the IFRS 16 accounting impact ratios are essential. For Australian companies, the same applies under lease accounting AASB 16. With IFRS 16 explained in simple terms, businesses can stay compliant and help investors clearly see their financial position.
Need expert help implementing IFRS 16? Contact Hubdigit today
Common Queries
1. What are the key points of IFRS 16?
It makes companies show all lease details, payments, and changes to assets and liabilities for clear and accurate reports.
2. What is a lease modification under IFRS 16?
It’s any change to the lease terms, time, asset, or payments.
3. What are the key changes in IFRS 16?
It puts almost all leases on the balance sheet and changes metrics like gearing ratio and EBITDA, which can affect loans, credit ratings, and how others see the company.