IFRS 16 Lease Accounting Example: Step by Step
A company leases a warehouse for five years at £20,000 a year, paid at the end of each year. Its incremental borrowing rate is 5%. Here is the full IFRS 16 treatment, one step at a time.
1. Measure the lease liability
The lease liability is the present value of the lease payments not yet paid, discounted at the rate implicit in the lease or, if that can’t be determined, the lessee’s incremental borrowing rate.
2. Measure the right-of-use asset
The right-of-use asset starts at the lease liability, plus any initial direct costs and payments made before commencement, less any lease incentives received. None apply here, so the asset equals the liability: £86,590.
3. Build the liability schedule
Each year, interest accrues on the opening balance at 5%. The payment covers that interest first; the rest reduces the liability.
| Year | Opening | Interest 5% | Payment | Closing |
|---|---|---|---|---|
| 1 | 86,590 | 4,329 | 20,000 | 70,919 |
| 2 | 70,919 | 3,546 | 20,000 | 54,465 |
| 3 | 54,465 | 2,723 | 20,000 | 37,188 |
| 4 | 37,188 | 1,859 | 20,000 | 19,048 |
| 5 | 19,048 | 952 | 20,000 | 0 |
4. Depreciate the asset
With no transfer of ownership, the asset is depreciated straight-line over the lease term: £86,590 / 5 = £17,318 a year.
5. What changes in the financial statements
Under the old operating-lease approach, profit and loss showed £20,000 of rent every year. Under IFRS 16, year one shows £21,647 (interest £4,329 + depreciation £17,318). The total over five years is still £100,000, but more of it falls in the early years because interest is highest when the liability is largest. EBITDA rises, because rent is replaced by depreciation and interest, which sit below it.
Common mistakes
- Recording the payment as rent expense.
- Using a rate that is not consistent with the payment frequency.
- Forgetting that initial direct costs go to the asset, not the liability.