IFRS 16 introduced a major change in how businesses account for leases. Under the standard, most leases are recognized on the lessee’s balance sheet through a right-of-use (ROU) asset and a lease liability. This approach provides a clearer view of a company’s lease obligations and the assets it has the right to use.

Understanding IFRS 16 accounting entries is important for finance teams, accountants, auditors, and businesses that manage office premises, vehicles, equipment, warehouses, machinery, or other leased assets. The accounting process involves several stages, including initial recognition, measurement of the lease liability, recognition of the right-of-use asset, depreciation, interest expense, lease payments, and lease modifications.

This guide explains the key IFRS 16 journal entries with practical examples to help businesses understand how lease transactions should generally be recorded.

What Is IFRS 16?

IFRS 16 is the international accounting standard that deals with leases. It applies to companies reporting under IFRS and establishes principles for recognizing, measuring, presenting, and disclosing leases.

For lessees, IFRS 16 generally requires a lease to be recognized on the balance sheet unless it qualifies for one of the available exemptions. The two common exemptions are:

• Short-term leases
• Leases of low-value assets

For most other leases, the lessee recognizes:

1. A right-of-use asset
2. A lease liability

Instead of recording the entire lease payment as a simple rental expense, the lessee normally recognizes depreciation of the ROU asset and interest on the lease liability over the lease term.

Understanding the Two Main IFRS 16 Accounts

Before looking at the journal entries, it is useful to understand the two primary accounts created when a lease begins.

Right-of-Use Asset

The right-of-use asset represents the lessee’s right to use an underlying asset for a specified period.

For example, if a company leases an office building for five years, the ROU asset represents its right to use that office during the contractual lease period.

Lease Liability

The lease liability represents the present value of lease payments that the lessee is required to make during the lease term.

The liability is subsequently increased by interest and reduced when lease payments are made.

Initial Recognition of a Lease

At the commencement date, a lessee generally recognizes the ROU asset and lease liability.

The lease liability is initially measured at the present value of unpaid lease payments. The discount rate is generally the interest rate implicit in the lease if that rate can readily be determined. Otherwise, the lessee generally uses its incremental borrowing rate.

A simplified initial entry is:

Journal Entry:

For example, assume a company enters into a five-year lease with annual payments of $20,000 payable at the end of each year. If the present value of the lease payments is calculated at $86,590, the initial entry would be:

This entry recognizes both the asset and liability at the commencement of the lease.

Initial Measurement of the Right-of-Use Asset

The ROU asset is not always equal to the lease liability. Depending on the circumstances, the initial cost of the ROU asset can include several components.

These may include:

• The initial measurement of the lease liability
• Lease payments made at or before commencement, less lease incentives received
• Initial direct costs incurred by the lessee
• Estimated costs associated with dismantling, removing, or restoring the underlying asset or location, when applicable

For example, suppose:

• Initial lease liability = $86,590
• Initial direct costs = $2,000
• Lease payment made before commencement = $5,000

The ROU asset may initially be measured at $93,590, subject to the specific facts and IFRS 16 requirements.

The accounting entry could be:

The exact treatment depends on the nature and timing of the payments.

IFRS 16 Depreciation Entry

After initial recognition, the ROU asset is generally depreciated over the lease term or the useful life of the underlying asset, depending on the circumstances.

If ownership transfers to the lessee by the end of the lease term, or the lessee is reasonably certain to exercise a purchase option, depreciation is generally based on the useful life of the underlying asset.

Otherwise, depreciation is generally recognized over the shorter of the asset’s useful life and the lease term.

For example, suppose the ROU asset is $90,000 and the lease term is five years. Assuming straight-line depreciation:

Annual depreciation = $90,000 ÷ 5 = $18,000

The journal entry would be:

This entry is normally recorded during each accounting period.

IFRS 16 Interest Expense Entry

The lease liability is subsequently measured using an interest-based approach.

Interest is calculated by applying the relevant discount rate to the outstanding lease liability.

For example, if the opening lease liability is $86,590 and the applicable annual discount rate is 6%, the interest expense for the first year would be:

$86,590 × 6% = $5,195.40

The journal entry would be:

The interest component increases the lease liability before the lease payment is applied.

IFRS 16 Lease Payment Entry

When the lease payment is made, it reduces the lease liability.

Suppose the annual lease payment is $20,000. After recognizing interest of $5,195.40, the payment entry can be recorded as:

The overall effect is that the lease liability is increased by interest and reduced by the cash payment.

In simplified form:

Closing lease liability = Opening liability + Interest – Lease payments

Using the example:

$86,590 + $5,195.40 – $20,000 = $71,785.40

Therefore, the closing lease liability after the first payment would be approximately $71,785.40.

Complete IFRS 16 Example

Consider a company that enters into a five-year equipment lease.

Assume:

• Lease term: 5 years
• Annual payment: $20,000
• Payment frequency: annually in arrears
• Discount rate: 6%
• Present value of lease payments: $86,590
• Initial ROU asset: $86,590
• Straight-line depreciation over five years

The accounting entries can be summarized as follows.

Step 1: Initial Recognition

Step 2: Recognize Depreciation

Annual depreciation:

$86,590 ÷ 5 = $17,318

Entry:

Step 3: Recognize Interest

First-year interest:

$86,590 × 6% = $5,195.40

Entry:

Step 4: Record Lease Payment

The same basic process continues throughout the lease, although the interest component generally decreases as the lease liability is reduced.

IFRS 16 Accounting for Lease Incentives

Lease incentives can affect the initial measurement of the ROU asset.

For example, a landlord may provide a rent-free period or make a cash contribution toward lease-related costs. Such incentives generally reduce the cost of the ROU asset when determining the initial measurement.

The accounting should therefore consider the full contractual payment schedule and applicable incentives rather than simply recording the headline rental amount.

IFRS 16 Accounting for Variable Lease Payments

Some leases contain variable payments. These payments can depend on factors such as an index, a rate, sales, or usage.

The treatment depends on the nature of the variable payment.

For example, variable lease payments linked to an index or rate can affect the measurement of the lease liability. Payments that are genuinely variable and depend on future activity, such as certain sales-based payments, may be recognized differently.

When lease payments change because of an index or rate, the lessee may need to remeasure the lease liability and adjust the ROU asset.

IFRS 16 Lease Modification Entries

Lease modifications occur when the scope of a lease changes or the consideration for a lease changes without being part of the original terms and conditions.

Examples include:

• Adding additional leased space
• Extending the lease term
• Removing part of the leased asset
• Changing contractual payments

Depending on the circumstances, the lessee may need to remeasure the lease liability and adjust the ROU asset.

For a modification that is accounted for as a separate lease, the accounting differs from a modification that is not a separate lease. Therefore, companies should assess the contractual change carefully before preparing the journal entry.

Remeasurement of the Lease Liability

A lease liability may need to be remeasured when there is a change in lease payments resulting from certain changes in the lease term, purchase option assessment, or payments linked to an index or rate.

The revised liability is generally recognized with a corresponding adjustment to the ROU asset, subject to the requirements of IFRS 16.

A simplified entry may look like:

If the remeasurement reduces the lease liability, the accounting can result in a corresponding reduction in the ROU asset, with any amount exceeding the carrying amount of the ROU asset recognized in profit or loss as required by the standard.

Short-Term and Low-Value Lease Exemptions

IFRS 16 provides practical exemptions for certain leases.

A lessee can elect to apply the short-term lease exemption to qualifying leases with a lease term of 12 months or less, subject to the requirements of the standard.

The low-value asset exemption can also apply to qualifying leases involving assets that are considered low value.

When an exemption is applied, the accounting is generally closer to traditional operating lease expense recognition rather than recognizing an ROU asset and lease liability.

For example:

Businesses should establish an accounting policy for these exemptions and apply the relevant requirements consistently.

IFRS 16 Entries for Finance Teams

An effective IFRS 16 accounting process should include more than simply creating an opening journal entry. Finance teams should maintain a lease schedule that tracks:

• Opening lease liability
• Interest expense
• Lease payments
• Closing lease liability
• Opening ROU asset
• Depreciation expense
• Closing ROU asset
• Lease modifications
• Remeasurements
• Lease incentives
• Changes in lease terms

A lease amortization schedule can make monthly and annual accounting entries easier to manage and can help reconcile the general ledger with the underlying lease contracts.

Common IFRS 16 Accounting Mistakes

Businesses can encounter several problems when implementing IFRS 16.

1. Recording Rent Expense Only

Simply recording monthly rent expense may not be appropriate for leases that fall within IFRS 16’s recognition requirements.

2. Using the Wrong Discount Rate

The discount rate has a significant impact on the initial lease liability and ROU asset. Businesses should document how the applicable rate was determined.

3. Ignoring Lease Modifications

Changes to lease terms can require reassessment or remeasurement. Failing to identify modifications can cause lease balances to become inaccurate.

4. Incorrect Depreciation Period

The depreciation period for the ROU asset should reflect the relevant requirements and contractual circumstances.

5. Poor Lease Data

Incomplete information about renewal options, termination clauses, payment increases, incentives, and variable payments can lead to incorrect calculations.

Importance of Accurate IFRS 16 Accounting Entries

Accurate IFRS 16 accounting entries help ensure that lease assets, liabilities, depreciation, and finance costs are properly reflected in the financial statements.

For businesses with multiple leases, manual calculations can become difficult to manage. A structured lease register and amortization schedule can help finance teams monitor contractual information and maintain consistent accounting records.

Companies should also reconcile their lease schedules with the general ledger and review significant changes during each reporting period.

Conclusion

IFRS 16 accounting entries require businesses to look beyond traditional rental expense accounting. For most leases, the process begins by recognizing a right-of-use asset and lease liability. Subsequent accounting normally involves depreciation of the ROU asset, interest on the lease liability, and reduction of the liability through lease payments.

Businesses should also consider lease incentives, variable payments, modifications, remeasurements, renewal options, and applicable exemptions. Maintaining accurate lease data and a detailed amortization schedule can make the accounting process more reliable and support accurate financial reporting.

Because lease arrangements can vary significantly, the exact accounting treatment should be assessed against the specific contractual terms and the applicable requirements.