IFRS Decoded #1 | IFRS 16 Bringing Lease Deals Out of the Shadows!

Imagine trying to understand how much a company genuinely owes, but a significant portion of its financial promises – such as long-term rent for its offices, factories, or even delivery lorries – was kept off the main “debt” list. This was a common practice for many businesses before 2019, meaning their financial health wasn’t always fully visible.

Then came IFRS 16. This accounting standard, which businesses worldwide began following from 1st January 2019, changed everything. Its straightforward aim: to ensure all substantial rental agreements (known as “leases”) are clearly presented on a company’s primary financial statement, the balance sheet. This means no more financial surprises when it comes to long-term rentals!

Why IFRS 16 Matters: The Hidden Scale of Leasing

The global leasing market is a cornerstone of business operations, with companies projected to enter lease agreements worth approximately £1.5 trillion ($1.89 trillion USD) in 2024, expected to grow to £2.4 trillion ($3 trillion USD) by 2029. A significant driver is the global commercial real estate market, valued at over £95 trillion ($120 trillion USD) in 2025, with an anticipated growth of £339 billion ($427 billion USD) by 2029. This market spans office spaces, retail units, industrial facilities, multi-family residential properties, and emerging sectors like data centers and sustainable real estate.

Key regions like Asia-Pacific (42% of market activity), North America, and Europe fuel this growth, with emerging markets in the Middle East and South America gaining momentum. Trends such as limited new property supply, rising costs, and shifts like remote work and e-commerce are reshaping leasing strategies, with many companies opting to renew existing leases rather than relocate. In recent years, commercial lease transactions have surpassed £790 billion ($1 trillion USD) annually, underscoring their economic significance.

Before IFRS 16, companies could commit to billions in future lease payments without reflecting these as liabilities on their balance sheets. This practice masked their true financial leverage, making some businesses appear less indebted than they were. IFRS 16 addresses this by requiring nearly all leases to be recognized as assets and liabilities, aligning financial reporting with economic reality.

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The Core Objectives of IFRS 16

IFRS 16 was introduced to achieve two fundamental goals:

1. Enhanced Transparency | To provide stakeholders – investors, lenders, and management – with a complete view of a company’s financial commitments, particularly long-term lease obligations.

2. Improved Comparability | To standardize how companies report leases, enabling fairer comparisons between businesses that own assets outright and those that lease them.

For business leaders, this means more reliable data for assessing financial health, negotiating contracts, or benchmarking against competitors.

A Practical Example | Global Goods PLC’s Shop Lease

To truly grasp IFRS 16, let’s stick with our example: Global Goods PLC signs a deal to rent a shop for 5 years. They agree to pay €10,000 every year in rent.

Pre-IFRS 16 (Before 2019)

Global Goods PLC would simply record €10,000 as a “rent expense” on its annual profit and loss report. The substantial 5-year commitment (a total of €50,000 in payments) was not shown as an asset or a debt on the balance sheet. It was, in effect, a significant “off-balance sheet” obligation.

Post-IFRS 16 (From 2019 Onward)

Now, Global Goods PLC must put this rental agreement directly on its balance sheet. How?

1. They get an “Asset” | This asset is called a “Right-of-Use Asset.” It represents Global Goods PLC’s right to use the shop for 5 years. It’s like they have a valuable right to control and benefit from the property, even if they don’t own the building outright.

2. They get a “Debt” | This debt is called a “Lease Liability.” It represents the future rent payments Global Goods PLC owes for those 5 years. This is treated just like any other loan a company might take out.

The “Today’s Value” Calculation (No need for complicated maths!)…

IFRS 16 requires us to look at those future €10,000 payments not just as simple additions, but to work out what they are worth today. This is because money you have today is worth more than the same amount of money you’ll receive in the future.

Let’s imagine the “interest rate” Global Goods PLC would pay if it borrowed money for something similar is 5%. When we use this 5% to calculate the “today’s value” of those five €10,000 payments, the amount comes to approximately €43,295.

So, on Day 1, Global Goods PLC records this on its books…

• DEBIT | Right-of-Use Asset: €43,295 (This is a brand new asset on the company’s “what we own” list!)
• CREDIT | Lease Liability: €43,295 (This is a brand new debt on the company’s “what we owe” list!)

What Happens Each Year of the 5-Year Lease…?

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The accounting doesn’t stop on Day 1. Each year, as Global Goods PLC uses the shop and makes payments, things change:

1. Paying Down the Debt | When Global Goods PLC pays the €10,000 annual rent, a portion of it reduces the Lease Liability (the debt).

2. Paying Interest | Another portion of that €10,000 payment is for interest on the outstanding Lease Liability. It’s just like paying interest on a loan.

– In Year 1, the interest expense is 5% of €43,295 = €2,165.

3. “Using Up” the Asset (Depreciation) | The “Right-of-Use” Asset is also gradually used up over the 5 years. This is called depreciation.

– Depreciation for the asset in Year 1 is €43,295 / 5 years = €8,659.

Let’s see the figures for Year 1 for Global Goods PLC…

• Cash Paid (Rent) | €10,000

• Expenses Reported |

– Interest Expense: €2,165

– Depreciation Expense: €8,659

• Total Expenses impacting profit | €2,165 + €8,659 = €10,824 (Note that this is slightly more than the €10,000 cash paid, primarily due to interest being higher in the earlier years of a loan/lease).

And the impact on the balance sheet at the end of Year 1…

• Lease Liability (Debt) | Starts at €43,295. We add the interest (€2,165) and then subtract the €10,000 payment. So, the debt reduces to €35,460.

• Right-of-Use Asset (Asset) | Starts at €43,295. We subtract the depreciation (€8,659). So, the asset’s value decreases to €34,636.

Exceptions for Simplicity

IFRS 16 acknowledges that not all leases are massive. If Global Goods PLC rents a small photocopier for only 6 months, or a low-cost office chair (typically valued under £4,000 / $5,000 when new), they do not have to put it on the balance sheet. These small or short-term leases can still be recorded as a simple “rent expense” each year, saving companies time and effort for minor items.

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The Big Impact | What Does This Mean for Financial Reports?

This isn’t merely an accounting adjustment; it fundamentally alters how a company’s financial story is presented.

• Balance Sheet Appears “Heavier”

– BEFORE 2019 | The company’s balance sheet looked “lighter” because significant lease commitments weren’t shown as assets or debts.

– NOW with IFRS 16 | The balance sheet immediately displays more assets (Right-of-Use Assets) and more debt (Lease Liabilities). For businesses with numerous leases (such as airlines, hotel chains, or retailers, which saw average increases of 14% in total assets and 20% in liabilities), their total assets and total liabilities can jump significantly! This provides a much more complete picture of their resources and obligations.

• Income Statement Changes

– BEFORE 2019 | Just one “Rent Expense” line.

– NOW with IFRS 16 | The single rent expense is replaced by two separate expenses: “Depreciation Expense” and “Interest Expense.”

– Because interest is generally higher at the beginning of a lease and decreases over time, a company’s reported profit might appear slightly lower in the initial years of a lease and slightly higher in later years compared to the previous method.

• Key Financial Ratios are Affected

– Debt-to-Equity Ratio | This ratio shows how much debt a company has compared to its owners’ funds. With IFRS 16 adding more “lease debt,” this ratio will generally increase, making a company appear more leveraged.

– EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortisation) | This is a popular measure of core business performance. Because “rent expense” used to be subtracted to arrive at EBITDA, but now “depreciation” and “interest” are below the EBITDA line, EBITDA figures typically appear higher under IFRS 16! This doesn’t mean the company is actually generating more cash, simply that the accounting method for certain expenses has changed.

• Strategic Decision-Making

– Lease vs. Buy | IFRS 16 levels the playing field by making leased assets’ financial impact comparable to owned assets, prompting leaders to reassess leasing strategies.

– Contract Negotiations | Understanding lease liabilities can influence negotiations with landlords, lenders, or investors, as transparency highlights long-term commitments.

– Investor Communication | Managers must clearly explain IFRS 16’s impact on financial metrics to maintain stakeholder confidence, especially in lease-intensive sectors.

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Actionable Takeaways for Professionals

1. Review Financial Statements | Regularly analyze balance sheets and income statements to understand lease-related assets and liabilities. Compare these with industry peers to benchmark leverage and performance.

2. Engage with Finance Teams | Collaborate with accountants to model IFRS 16’s impact on key metrics like EBITDA and debt ratios, ensuring alignment with strategic goals.

3. Educate Stakeholders | Proactively communicate how IFRS 16 affects financial reports to investors, board members, and lenders to avoid misinterpretations.

4. Optimize Leasing Strategies | Evaluate lease terms (e.g., shorter durations or low-value exemptions) to balance financial flexibility with IFRS 16 compliance.

Conclusion: Empowering Smarter Decisions in a Trillion-Pound Market

IFRS 16 transforms how businesses report their role in the £1.5 trillion global leasing market, bringing unprecedented clarity to financial obligations. By recognizing leases as assets and liabilities, it ensures that managers, directors, and stakeholders have a transparent, comparable view of a company’s commitments. For professionals, mastering IFRS 16 is not just about compliance—it’s about leveraging clearer financial insights to drive strategic decisions, optimize resource allocation, and build trust in a competitive, lease-driven economy.

This article was prepared by the AccountingWise.