IFRS 16 (i): lessee accounting

For years, a company could lease a fleet of aircraft, a chain of shops or a power plant and show almost nothing in its statement of financial position, as long as the lease was labelled an “operating lease”. The rights and the obligations were real, but readers could not see them. International Financial Reporting Standard (IFRS) 16, Leases, ended that for lessees.

A lessee now recognises almost every lease as an asset (the right to use the item) and a liability (the duty to pay for it).

This topic covers the lessee’s side: identifying a lease, separating components, the lease term and lease payments, initial measurement, subsequent measurement, the interest schedule and the current and non-current split, the exemptions, presentation and disclosure, and the remeasurement and modification of a lease. The next topic covers lessors and sale and leaseback. May 2026 Question 7(b) tested a lease that had become loss-making.

Key terms in plain English

Syllabus check

IFRS 16 is examinable under syllabus area B (reporting of performance and position, non-financial assets and liabilities). This topic covers:

• identifying leases and separating components;
• recognition and measurement of the right-of-use asset and lease liability by lessees;
• reassessment, remeasurement and modification;
• exemptions, presentation and disclosure;
• the effect on gearing, earnings before interest, tax, depreciation and amortisation (EBITDA) and return ratios in analysis.

CAMA 2020 and leases

The Companies and Allied Matters Act 2020 (CAMA 2020) requires statements that follow IFRS and give a true and fair view.

Scope

IFRS 16 applies to all leases except leases for the exploration for or use of minerals and oil, leases of biological assets, service concession arrangements, licences of intellectual property granted by a lessor, and rights held under licensing agreements within the scope of International Accounting Standard (IAS) 38 (patents, copyrights). A lessee may apply IFRS 16 to other intangible leases.

A portfolio of similar leases may be accounted for together if the result would not differ materially.

Is there a lease?

Some contracts do not look like leases but are, such as outsourcing deals and telecoms capacity contracts. The test is made at inception and repeated only if the terms change.

A contract is or contains a lease if the customer has the right to control the use of an identified asset for a period of time. That needs both:

1. the right to obtain substantially all the economic benefits from use of the asset; and
2. the right to direct the use of the asset: how and for what purpose it is used throughout the period (or those decisions are predetermined and cannot be changed by the supplier).

Identified asset

The asset may be named in the contract or identified when it is delivered. If the supplier has a substantive right to substitute the asset throughout the period (the practical ability to do so and an economic benefit from doing so), there is no identified asset. A right to swap only for repair or after a future event is not substantive.

Separating components

A contract may include lease and non-lease components (such as maintenance). The lessee allocates the payment on the basis of relative stand-alone prices, estimating them if they are not observable. A lessee may elect, by class of asset, not to separate and to treat the whole as a lease. A lessor applies IFRS 15 to allocate the consideration.

Lease term and lease payments

Lease term = the non-cancellable period + periods covered by an option to extend if the lessee is reasonably certain to use it + periods covered by an option to terminate if the lessee is reasonably certain not to use it. A cheap extension (for example a nominal rent) is likely to be used. One at a much higher rent is unlikely.

Lease payments include:

• fixed payments (including in-substance fixed payments), less lease incentives;
• variable payments that depend on an index or a rate (measured at the index or rate at the start date);
• the exercise price of a purchase option if the lessee is reasonably certain to use it;
• penalties for terminating, if the lease term reflects the lessee terminating; and
• amounts expected to be payable by the lessee under residual value guarantees.

Variable payments that depend on something else, such as a percentage of the lessee’s sales, are not lease payments. They are expensed as incurred.

Note: ICAN’s worked examples include the whole guaranteed residual value as a lease payment and depreciate the asset down to that residual value. That is the older approach.

IFRS 16 includes only the amount the lessee expects to pay under the guarantee (nothing, if the asset is expected to be worth at least the guaranteed amount). The right-of-use asset is depreciated over the lease term without deducting a residual value unless ownership passes. We teach the IFRS 16 treatment, so ICAN’s practice solutions are slightly different from ours.

In the exam, follow the instructions in the question, and if a question includes a guaranteed residual value in the liability, say what IFRS 16 requires and show the calculation the question asks for.

Initial measurement

Lease liability

The present value of the lease payments not yet paid at the commencement date, discounted at the interest rate implicit in the lease or, if that cannot be readily determined, the lessee’s incremental borrowing rate.

Right-of-use asset

Subsequent measurement

The asset

The cost model applies: cost less accumulated depreciation and impairment (IAS 36). Depreciation runs over the shorter of the lease term and the useful life, or over the useful life if ownership transfers or the lessee is reasonably certain to buy. If the lessee uses the IAS 40 fair value model, that applies to right-of-use assets that are investment property.

If a class of property, plant and equipment is revalued, the lessee may revalue the matching right-of-use assets.

The liability

Opening liability + interest at the discount rate − payments = closing liability. Interest is a finance cost in profit or loss, shown separately from depreciation. Each payment is partly interest and partly repayment of the liability. The effective interest method gives a constant rate on the balance, so interest falls as the balance falls.

Current and non-current

At each year end the current liability is the principal that will be repaid in the next 12 months (next payment less the interest on the balance for next year, for payments in arrears). The rest is non-current. For payments in advance, the next payment due immediately after the year end is current, and part of it is interest already accrued.

Payments in advance

If the first payment is made on day one, it is not part of the liability after that date. It is added to the cost of the right-of-use asset and deducted from the liability. Interest then runs on the balance after that payment.

Exemptions

A lessee may elect not to apply the rules to short-term leases (12 months or less, with no purchase option) and leases of low-value assets (for example laptops and phones). The election is by class of asset for short-term leases and lease by lease for low-value leases. The payments are expensed on a straight-line or other systematic basis.

Presentation and disclosure

• Statement of financial position: right-of-use assets and lease liabilities are shown separately or disclosed in the notes. Right-of-use assets that meet the definition of investment property are shown as investment property.
• Profit or loss: depreciation of the right-of-use asset and interest on the liability are shown separately.
• Cash flows: the principal portion is a financing outflow. The interest portion follows IAS 7 for interest paid. Short-term, low-value and variable payments not in the liability are operating.
• Notes: depreciation by class, interest expense, short-term, low-value and variable lease expense, income from subleasing, total cash outflow, additions to right-of-use assets, sale and leaseback gains or losses, carrying amounts by class and a maturity analysis of undiscounted lease payments (which is reconciled to the liability by deducting future finance charges).

Remeasurement and modification

Remeasuring the liability

The lease liability is remeasured when circumstances change under the original terms. The adjustment goes to the right-of-use asset (any excess over a nil carrying amount goes to profit or loss).

Lease modification

A modification is a change in scope or consideration that was not part of the original terms (for example adding an asset, or extending the term by agreement). Exercising an existing option is a reassessment, not a modification.

• Separate lease: if the modification adds the right to use one or more assets and the extra payment matches the stand-alone price of the addition (adjusted for the circumstances), it is accounted for as a new lease. The original lease is unchanged.
• Not a separate lease: the liability is remeasured at a revised discount rate. If the scope has been reduced, the right-of-use asset is reduced in proportion and the difference between the change in liability and the asset reduction is a gain or loss in profit or loss. For other modifications the change in liability adjusts the asset.

The rules in more depth

Why the whole lease is capitalised

A lessee that can use an asset for years and must pay for it has an asset and a liability whatever the label. Showing both gives a truer picture of gearing and assets used.

Why interest is front-loaded

Interest is charged on the balance. The balance is highest at the start, so the finance cost is highest at the start. Depreciation is straight line. The total charge in early years is therefore higher than the rent, and lower in later years.

Effect on analysis

• Assets and liabilities rise, so gearing and debt ratios worsen.
• Rent leaves operating costs, so EBITDA and operating profit rise. Interest and depreciation rise instead.
• Operating cash flow rises and financing outflow rises. Total cash is unchanged.
• Return on capital employed usually falls, because capital employed rises by more than profit.

Worked examples

1. Liability = ₦100,000 × 3.9927 = ₦399,271.
2. Right-of-use asset.
   ₦399,271 + ₦5,000 = ₦404,271.
   Entry: Dr right-of-use asset ₦404,271; Cr lease liability ₦399,271; Cr cash ₦5,000.
3. Depreciation = ₦404,271 ÷ 5 = ₦80,854 a year.

Total interest = ₦100,473 (₦500,000 payments less ₦399,271).

1. Closing liability = ₦331,213.
2. Next year’s principal repayment.
   ₦100,000 − Year 2 interest ₦26,497 = ₦73,503 (current).
3. Non-current = ₦331,213 − ₦73,503 = ₦257,710, which is the Year 2 closing balance.

1. Present value of the payments.
   ₦100,000 + ₦100,000 × 3.3121 = ₦431,213.
2. The first payment is made at commencement, so the lease liability recognised = ₦431,213 − ₦100,000 = ₦331,213.
3. Right-of-use asset.
   ₦331,213 + ₦100,000 (paid at commencement) + ₦5,000 = ₦436,213.
4. Entry: Dr right-of-use asset ₦436,213; Cr cash ₦105,000; Cr lease liability ₦331,213.

1. Revised payments: Years 4 and 5 ₦100,000 each, Years 6 and 7 ₦110,000 each.
   Present value at 9% = ₦91,743 + ₦84,168 + ₦84,940 + ₦77,927 = ₦338,778.
2. Adjustment = ₦338,778 − ₦178,327 = ₦160,451.
   Entry: Dr right-of-use asset ₦160,451; Cr lease liability ₦160,451.
3. New carrying amount.
   ₦161,658 + ₦160,451 = ₦322,109, depreciated over the 4 remaining years at ₦80,527 a year.

1. Asset at end of Year 4 = ₦1,522,800 × 2/6 = ₦507,600.
2. Liability before.
   ₦300,000 × 1.859 = ₦557,700.
3. Liability after.
   ₦200,000 × 1.833 = ₦366,600.
   Reduction = ₦191,100.
4. Asset reduced by one third = ₦169,200.
5. Gain in profit or loss.
   ₦191,100 − ₦169,200 = ₦21,900.
   Entry: Dr lease liability ₦191,100; Cr right-of-use asset ₦169,200; Cr profit or loss ₦21,900.

How to score full marks

• Start with the lease test: identified asset, substitution right, benefits and direction of use.
• State the lease term with the reasonably-certain test and say which options are included.
• Show the discount rate used and why (implicit rate, or incremental borrowing rate).
• Build the right-of-use asset from its four components.
• Lay out the schedule with opening balance, interest, payment and closing balance.
• Split current and non-current using the next year’s principal.
• For changes, decide first whether it is a reassessment, a separate-lease modification or another modification, and then use the right rate.

Common mistakes in the exam

• Treating a contract as a lease when the supplier can freely substitute the asset.
• Including variable payments based on sales in the liability.
• Forgetting initial direct costs and payments before commencement in the asset.
• Showing the whole next-year payment as the current liability instead of the principal part.
• Depreciating the asset over the useful life when the lease term is shorter.
• Using the original rate for a change in lease term.
• Calling the exercise of an existing option a modification.
• Showing rent as an operating expense for a capitalised lease.

Quick revision

• Lease: right to control an identified asset (substantially all benefits and direction of use).
• Liability: present value of unpaid payments at the implicit rate or incremental borrowing rate.
• Asset: liability + prepayments + initial direct costs + restoration − incentives. Depreciate over the shorter of lease term and life.
• Interest on the opening balance. Principal repaid is the current liability.
• Exemptions: 12 months or less, low value.
• Term or purchase option change: revised rate. Index or guarantee change: original rate.
• Modification: separate lease, or remeasure at a new rate, with a gain or loss for reduced scope.
• CAMA 2020: ss. 377(1), 378, 374(1), 385, 404(7).

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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