IFRS 16 Lessee Accounting: Right-of-use Asset, Lease Liability, Depreciation and Interest

Once a contract is a lease and no exemption applies, the lessee records two things at the start: an asset for the right to use the underlying asset and a liability for the payments it has agreed to make. After that, the asset is depreciated and the liability grows with interest and falls with each payment.

This topic covers how both are measured at the start and afterwards, how the interest table works, how the liability is split between current and non-current, what changes when rentals are paid in advance, and how leases are presented and disclosed. The next topic starts intangible assets.

In the diets reviewed for this page none of the questions read tests leases directly. The calculations are mechanical and reward a neat layout, so they are among the easiest marks in the course once the method is learned. Read identifying a lease, the lease term and the exemptions first.

Initial measurement

A lease is recognised at the commencement date: Dr Right-of-use asset, Cr Lease liability (with cash for any amounts paid at the start).

The lease liability

The lease liability is the present value of the lease payments that have not been paid at the commencement date. The discount rate is the interest rate implicit in the lease or, if it cannot be readily determined, the lessee’s incremental borrowing rate. The liability is the capital the lessee will repay over the lease term.

Amounts paid at or before commencement and the lessee’s initial direct costs are not part of the liability.

The right-of-use asset

The right-of-use asset is measured at the commencement date as the sum of:

1. the initial measurement of the lease liability;
2. lease payments made at or before the commencement date, less any lease incentives received;
3. the lessee’s initial direct costs; and
4. an estimate of the costs of dismantling and removing the asset and restoring the site, where the lessee has that obligation.

Subsequent measurement

The asset

After commencement the right-of-use asset is measured on the cost model: cost less accumulated depreciation and impairment (International Accounting Standard (IAS) 16 and IAS 36 apply). If the lessee uses the fair value model for investment property, it uses it for right-of-use assets that are investment property. If it revalues a class of property, plant and equipment, it may revalue right-of-use assets in that class. The asset is depreciated from the commencement date:

• to the end of its useful life if the lease transfers ownership by the end of the term, or the cost reflects that the lessee will exercise a purchase option; or
• otherwise to the earlier of the end of its useful life and the end of the lease term, that is, over the shorter of the two.

The liability

Each lease payment has two parts: a finance charge on the liability and a repayment of part of the liability. The finance charge is recognised in profit or loss as a finance cost, spread so as to provide a constant rate of charge on the outstanding obligation. This actuarial method applies the discount rate to the opening balance, so the interest falls each year as the liability falls.

Total payments exceed the amount first recognised, and the total finance charge is the difference between the total lease payments and the initial liability.

Current and non-current liability

The liability is split between the part due within 12 months (current) and the rest (non-current). The current part is the principal repaid in the next year, which is the next payment less the interest that accrues in that next year. Find one from the table and take the other as the balancing figure.

Payments in advance

If rentals are paid at the start of each year, the first payment is made at commencement, so it is not in the liability. It goes into the right-of-use asset instead. At each later year end the payment due on the first day of the next year is a current liability: it contains the interest accrued in the year just ended and some principal.

The total finance charge is the same as for payments in arrears if the implicit rate is used, although the rate itself is different.

Residual value guarantees

If the lessee guarantees the asset’s value at the end of the lease, the expected guaranteed amount is part of the lease payments and so of the liability. The asset is depreciated down to that value. At the end of the lease the asset is handed back and the final payment is made up of the last rental plus the guaranteed amount.

The guaranteed amount is settled by transferring the asset: Dr Lease liability, Cr Right-of-use asset. If the asset is worth less than the guarantee, the lessee pays the shortfall in cash and writes the asset down to its value at the transfer.

Presentation and disclosure

• Statement of financial position: right-of-use assets and lease liabilities are shown separately or disclosed in the notes. If right-of-use assets are not separate, they are included in the line that would hold the same assets if owned, and that is disclosed. Right-of-use assets that are investment property are shown as investment property.
• Profit or loss: interest on the lease liability is a finance cost, shown separately from depreciation of the right-of-use asset.
• Cash flows: payments of the principal part of the liability are financing activities. The interest part follows the requirements for interest paid in IAS 7. Short-term and low-value lease payments and variable payments not in the liability are operating activities.

The notes, in a single note or section, disclose for the period:

• depreciation of right-of-use assets by class
• interest on lease liabilities
• the expense for short-term leases, low-value leases and variable payments not in the liability
• income from subleasing
• total cash outflow for leases
• additions to right-of-use assets
• gains or losses from sale and leaseback
• the carrying amount of right-of-use assets at the end by class

A maturity analysis of the undiscounted lease payments is also given, separately from other financial liabilities. It does not equal the liability, which is discounted, but the two reconcile by deducting future finance charges.

The ideas in more depth

Why the early years cost more

Depreciation is level, but interest is highest at the start when the liability is largest. The total charge in the first years is therefore higher than the rent paid, and lower in the last years. Over the whole lease the total charge equals the total rent plus any initial direct costs.

When the lease changes

If the lease term or lease payments change, for example an extension is exercised that was not expected, the liability is remeasured by discounting the revised payments and the adjustment is made to the right-of-use asset. This topic examines the standard case where the terms stay fixed.

Sources and references

• International Financial Reporting Standard (IFRS) 16 Leases: lessee recognition, measurement, presentation and disclosure.
• IAS 16 Property, Plant and Equipment, IAS 36 Impairment of Assets, IAS 7 Statement of Cash Flows and IAS 40 Investment Property, for the cross-references above.

These points are stated as at 5 November 2026.

Worked examples

1. Liability.
   ₦300,000 × 2.4018 (the three-year annuity factor at 12%) = ₦720,549.
2. Right-of-use asset.
   ₦720,549 + ₦15,000 = ₦735,549.
   Depreciation over the 3-year lease term = ₦735,549 ÷ 3 = ₦245,183 a year.
3. Interest table.

   Year	Opening	Interest at 12%	Payment	Closing
   1	₦720,549	₦86,466	₦(300,000)	₦507,015
   2	₦507,015	₦60,842	₦(300,000)	₦267,857
   3	₦267,857	₦32,143	₦(300,000)	nil

4. Total finance charge.
   ₦900,000 − ₦720,549 = ₦179,451, which equals ₦86,466 + ₦60,842 + ₦32,143.
5. End of Year 1.
   Right-of-use asset ₦735,549 − ₦245,183 = ₦490,366.
   Liability ₦507,015, of which current is ₦300,000 − ₦60,842 = ₦239,158, and non-current ₦267,857.
6. Profit or loss, Year 1.
   Depreciation ₦245,183 + interest ₦86,466 = ₦331,649, compared with cash rent of ₦300,000.

1. Liability. The first payment is made at commencement.
   The liability covers the other two: ₦300,000 × 1.6901 = ₦507,015.
2. Right-of-use asset.
   ₦507,015 + ₦300,000 (first payment) + ₦15,000 = ₦822,015, depreciated at ₦274,005 a year.
3. Interest, Year 1.
   ₦507,015 × 12% = ₦60,842.
   Liability at the end of Year 1 = ₦507,015 + ₦60,842 = ₦567,857.
4. Split. The payment due on 1 January Year 2 is ₦300,000, so the current liability is ₦300,000 (interest ₦60,842 and principal ₦239,158). Non-current is ₦267,857.
5. Check.
   Total finance charge: ₦900,000 − (₦507,015 + ₦300,000) = ₦92,985, which equals ₦60,842 + ₦32,143.

1. Liability.
   Rentals: ₦200,000 × 3.1699 = ₦633,973.
   Guarantee: ₦60,000 × 0.6830 = ₦40,981.
   Total ₦674,954.
2. Interest. Year 1 ₦67,495, closing ₦542,449. Year 2 ₦54,245, closing ₦396,694. Year 3 ₦39,669, closing ₦236,363. Year 4 ₦23,636, closing ₦59,999 (treated as ₦60,000, a rounding difference).
3. Depreciation.
   The asset is depreciated to the guaranteed value: (₦674,954 − ₦60,000) ÷ 4 = ₦153,739 a year, leaving ₦60,000 at the end.
4. End of lease. The asset is handed back to settle the guarantee: Dr Lease liability ₦60,000, Cr Right-of-use asset ₦60,000.

How to answer in the exam

• Set out the method. Liability first, then the right-of-use asset, then depreciation, then the interest table. Label each.
• Build the table. Opening, interest, payment, closing. Check that the last closing balance is nil, allowing for rounding.
• Split current and non-current. Take next year’s principal as current, and the rest as non-current, then prove the total.
• Show the profit or loss effect. Depreciation and interest, separately.
• Explain. State the discount rate rule and the depreciation period rule.

Common mistakes in the exam

• Including the first payment in the liability when rentals are in advance.
• Leaving initial direct costs out of the right-of-use asset, or including them in the liability.
• Depreciating over the useful life when the lease is shorter and ownership does not pass.
• Calculating interest on the closing balance, or on the original liability every year.
• Showing the whole payment as an expense. It is depreciation plus interest, with the rest a repayment of the liability.
• Classing the interest as part of depreciation instead of showing it as a finance cost.

Quick revision

• Liability: present value of unpaid lease payments at the implicit rate or incremental borrowing rate.
• Asset: liability + payments at or before commencement − incentives + initial direct costs + dismantling estimate.
• Depreciate over the shorter of useful life and lease term, unless ownership passes or a purchase option is reasonably certain.
• Interest = opening liability × rate. Total finance charge = total payments − initial liability.
• Current liability = next year’s principal (or, in advance, the next payment).
• Cash flows: principal in financing; interest by the interest rule.

Practice questions

These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.

Recall check: multiple choice

Section B style: written questions

A further written question

Model answers

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