Lease Accounting Under IFRS 16: How Does Leasing Offices or Equipment Affect the Financial Statements?

Is every service contract or equipment arrangement a lease?

What matters is the substance of the rights and obligations, not the title of the contract alone. The analysis looks at whether there is an identified asset and a right to control its use for a period in exchange for consideration, under the standard’s conditions. A contract may include a service using assets the customer does not control in the way the definition requires, or it may combine lease and non-lease components that need appropriate treatment. ^{[1, 2]}

So ask for the contract, its amendments and a description of how it works in practice, and ask who decides how and for what purpose the asset is used, and what substitution rights the supplier has. Do not rely on the word “rental” or “subscription” on the invoice to decide the treatment. The team can prepare a short memo recording the facts, the conclusion and the reference, so similar cases are reviewed consistently without copying a conclusion from a contract that is different in substance.

What is recognised at the start of the lease?

Where the lessee model applies, a right-of-use asset is recognised, together with a liability representing the present value of the lease payments included in measurement under the standard. Measurement of the asset may be affected by other items, such as prior payments, incentives, initial direct costs and restoration obligations where they apply. The asset and the liability are not equal in every contract, even though they are equal in some simplified examples. ^{[1, 2]}

There are optional exemptions, subject to conditions, including certain short-term leases and leases of low-value assets. Their use cannot be inferred from a low monthly instalment or from management’s wish to simplify the accounts. The conditions, and how the policy is chosen and applied, must be checked. This article focuses on the lessee and does not cover the lessor model or every special case. ^[1]

How are the lease term and discount rate determined?

The accounting lease term may differ from the initial period written in the contract if there are extension or termination options and relevant economic evidence. A specialist reviews the non-cancellable period, the options and the enforceability of the contract under the standard. Decisions of the IFRS Interpretations Committee make clear that some assessments need to consider broader economics, not just the termination penalty written in the contract. ^[3]

The interest rate implicit in the lease is used if it can be readily determined; otherwise the lessee’s incremental borrowing rate is considered under the standard’s requirements. Do not pick one rate off the internet for every lease in the group; considerations of term, security, economic environment and more differ. The source of the rate and its assumptions should be documented and reviewed by a specialist, especially where its effect on measurement is significant. ^{[2, 4]}

How does a simplified worked example look?

Assume a three-year office lease, with a payment of 100,000 currency units at the end of each year and a hypothetical discount rate of 5% a year. Assume use starts immediately, with no prepayments, incentives, initial direct costs, restoration obligation, options or taxes, and no impairment or modifications. These are teaching assumptions set to illustrate the calculation, not market prices or recommended terms.

The present value is the sum of 100,000 ÷ 1.05, 100,000 ÷ 1.05² and 100,000 ÷ 1.05³, which comes to about 272,324.80 units. Under the example’s assumptions, this amount is the initial lease liability and the right-of-use asset. In the first year, interest is about 13,616.24, and the payment then reduces the liability to about 185,941.04. These figures are calculated from the stated assumptions; they are not entity data or published statistics.

Why does the expense differ from the cash payment?

In the example, if the right-of-use asset is depreciated on a straight-line basis over three years, annual depreciation is about 90,774.93 units. Adding first-year interest of about 13,616.24 gives a total of about 104,391.17, while the cash payment is 100,000. The difference shows that cash flow and the timing of expense are not the same thing; small rounding differences may appear in schedules.

Interest falls in later years as the liability balance falls in this example, while depreciation stays constant under its assumptions. Do not generalise this pattern to every contract without looking at its modifications and terms. Nor does recognising the asset mean the entity has bought ownership of the office, or the liability mean there is a new bank loan; they reflect the treatment of the right of use and the payments under the standard. ^{[1, 2]}

What documents does a lease file need?

Collect the contract, amendments, the date the asset was made available, the payment schedule, incentives, options and modifications, and the memo on the definition, term, rate and measurement. Link the liability and asset schedule to the journal entries and supporting documents, and decide who updates it when the contract changes. Do not leave the file in a personal spreadsheet whose assumptions and review method nobody knows when the preparer is away.

You can add a log of events that call for an accounting review, such as a change in space, term or consideration, or the exercise of an option. Not every change is treated the same way; a specialist decides whether it is a modification, a remeasurement or another event under the text. The log’s value is that it passes information from contract management or facilities to finance at the right time, instead of it being discovered at the annual audit.

Which mistakes should management watch for?

Operational mistakes include using the contract signing date instead of checking the commencement date, missing an amendment that finance never received, copying a discount rate without justification, or assuming that a short-term contract that keeps renewing automatically qualifies for the exemption. These are suggested review examples, and each case needs its own facts analysed. The list does not mean all these events lead to the same treatment.

Also check that the lease register is consistent with expenses, payments and the sites actually used. Reconciliation may reveal an asset in use that is missing from the register, or an expired lease whose entries keep recurring. When presenting indicators to management, explain the effect of the treatment on profit, assets, liabilities and contractual covenants, without concluding that a higher indicator means a real operational improvement.

How would this apply in a hypothetical Gulf entity?

A hypothetical entity leases an office and equipment from different suppliers, with operations holding the amendments and finance holding the invoices. The team creates a shared register of leases and events, and assigns responsibility for notifying finance of changes. It then analyses each contract on its substance, rather than applying the office example to the equipment automatically. The case illustrates how to organise information and gives no conclusion on any real contract.

In the Gulf, check the accounting framework the entity applies and the regulator’s requirements, keeping accounting separate from tax and legal treatment. This article does not address VAT, deductibility or property registration rules. Nor should the liability calculation be used to conclude that a contract’s legal terms are equivalent to a contract in another country; each aspect has its own reference and specialist.

How do you check the schedule before approving the entry?

Check the timing of payments; a payment at the start of a period differs from one at the end. Review time units and the rate, then reconcile the opening balance, interest, payments and closing balance. In the example, the liability should approach zero after the final payment, with explained rounding differences, not a remaining amount caused by a formula error.

Separate inputs from formulas, protect the calculation cells, and keep a reason for any change in assumptions. A result that looks reasonable is not enough; ask a reviewer to trace it to the contract and the measurement memo. As the number of leases grows, consider a suitable tool with input and review controls rather than extending an individual spreadsheet with no version control.

These are suggested controls, not the requirements of any particular software. An error in a date or a payment can repeat across periods if it is not caught, so reconciliation helps explain differences with the general ledger. Do not clear an unexplained difference with an adjusting entry without tracing its origin. If the calculation method changes or data moves to a new system, test leases with different characteristics, not just a simple case that matches the example. The review should cover irregular payments, options and modifications where they exist, under the supervision of a specialist who decides the right treatment for each case.