IFRS 16 Leases Practical Guide for Lessees

The practical answer

IFRS 16 requires most lessees to recognise a right-of-use asset and a lease liability. The difficult work happens before the journal entry: finding all contracts that may contain leases, identifying the asset, assessing who controls its use, determining the enforceable lease term, separating service components and obtaining a supportable discount rate.

A reliable process follows the contract from legal terms to accounting judgments, a present-value calculation, an approved lease schedule and periodic reconciliation. Posting equal monthly rent expense without this analysis is not the normal lessee model under IFRS 16, except when a recognition exemption is properly applied.

First identify a lease

A contract is or contains a lease when it conveys the right to control the use of an identified asset for a period of time in exchange for consideration. A contract called a service agreement may contain a lease, while a contract called a lease may include substantial service components.

Test	Practical question	Evidence to inspect
Identified asset	Is a specific asset explicitly or implicitly identified	Serial number location dedicated floor or other asset specification
Substitution rights	Can the supplier practically substitute the asset and benefit economically from doing so	Contract rights available alternatives and substitution economics
Economic benefits	Can the customer obtain substantially all economic benefits from use	Output by-products capacity third-party use and restrictions
Direction of use	Who decides how and for what purpose the asset is used	Decision rights operating instructions and predetermined design
Period and consideration	Is the right enforceable for a period in exchange for payment	Termination clauses renewal rights and payment terms

Practical example: A transport provider uses any truck from a large fleet to deliver goods and can substitute trucks throughout the contract. That may be a service rather than a lease. A dedicated truck identified by registration number, controlled by the customer and not practically substitutable may be a lease even if the contract is titled logistics services.

Scope and recognition exemptions

IFRS 16 contains scope exclusions for specified transactions such as certain mineral exploration rights, biological assets, service concession arrangements and some intellectual-property licensing rights. These exclusions should be checked before measurement.

A lessee may elect not to recognise right-of-use assets and lease liabilities for short-term leases and leases for which the underlying asset is of low value when new. The short-term exemption applies to a lease with a term of 12 months or less and no purchase option. The low-value assessment is based on the underlying asset when new; IFRS 16 does not establish a universal monetary threshold.

When an exemption is elected, lease payments are generally recognised as an expense on a straight-line basis or another systematic basis. The election, lease population and expense still require documentation. Repeatedly renewing cancellable arrangements without analysing the enforceable period is not a substitute for a lease-term assessment.

Determine the lease term

The lease term includes the non-cancellable period plus extension periods the lessee is reasonably certain to exercise and termination periods the lessee is reasonably certain not to exercise. Reasonable certainty is an economic assessment, not a casual forecast.

• Consider significant leasehold improvements, relocation costs, specialised location, favourable rent and operational dependence.
• Identify when both parties can terminate without more than an insignificant penalty, because enforceability affects the term.
• Reassess the lease term when a significant event or change in circumstances within the lessee's control changes the extension or termination assessment.

Build the initial measurement

Lease liability

At commencement, the lease liability is the present value of lease payments not yet paid. The payments can include fixed and in-substance fixed payments, less lease incentives receivable; payments linked to an index or rate using the index or rate at commencement; expected payments under residual value guarantees; a purchase-option price when exercise is reasonably certain; and termination penalties when the lease term reflects termination.

Use the interest rate implicit in the lease when it can be readily determined. Otherwise use the lessee's incremental borrowing rate for a borrowing over a similar term, with similar security, for an amount needed to obtain an asset of similar value in a similar economic environment. A general overdraft rate copied into every lease is rarely a sufficient policy.

Right of use asset

The right-of-use asset starts with the lease liability, then adds lease payments made at or before commencement, initial direct costs and recognised restoration obligations, and deducts lease incentives received. It is not automatically equal to the liability.

Lease and service components

A contract may include rent, maintenance, security or other services. A lessee generally allocates consideration to lease and non-lease components using relative stand-alone prices. A practical expedient permits combining components by class of underlying asset, but the policy choice can increase the recognised lease liability and must be applied consistently.

Worked example

FGL Services Ltd leases office equipment for three years. It pays UGX 120 million at each year-end. There are no initial direct costs, incentives, restoration obligations or purchase options. The incremental borrowing rate is 10 per cent. Amounts below are in UGX millions.

The initial liability is the present value of the three payments: 120 divided by 1.10, plus 120 divided by 1.10 squared, plus 120 divided by 1.10 cubed. The result is approximately 298.422. The initial right-of-use asset is also 298.422 in this simplified example.

Year	Opening liability	Interest at 10 percent	Payment	Closing liability
1	298.422	29.842	(120.000)	208.264
2	208.264	20.826	(120.000)	109.090
3	109.090	10.909	(120.000)	approximately nil

Because ownership does not transfer and there is no reasonably certain purchase option, the right-of-use asset is depreciated over the three-year lease term. Straight-line depreciation is approximately 99.474 each year.

Commencement entry

Entry	Account	Amount
Dr	Right of use asset	UGX 298.422 million
Cr	Lease liability	UGX 298.422 million

Year one entries

Entry	Account	Amount
Dr	Interest expense	UGX 29.842 million
Cr	Lease liability	UGX 29.842 million
Dr	Lease liability	UGX 120.000 million
Cr	Cash	UGX 120.000 million
Dr	Depreciation expense	UGX 99.474 million
Cr	Accumulated depreciation on right of use asset	UGX 99.474 million

The lease payment is not posted entirely to expense. It reduces the liability, while interest and depreciation are recognised separately. Rounding differences should be cleared in the final period without changing the economics of the schedule.

Accounting after commencement

After commencement, the lease liability increases for interest and decreases for payments. It is remeasured for specified reassessments, changes in lease payments and modifications. The right-of-use asset is generally measured at cost less accumulated depreciation and impairment, adjusted for qualifying remeasurements of the liability.

Depreciation normally runs from commencement to the earlier of the end of the right-of-use asset's useful life and the lease term. If ownership transfers or exercise of a purchase option is reflected in the asset's cost, depreciation runs over the useful life of the underlying asset. IAS 36 applies when impairment indicators exist.

Remeasurements and modifications

A schedule is not frozen on commencement day. Payments linked to an index or rate change when the contractual cash flows change. Extension or termination assessments can change after significant events within the lessee's control. Contract modifications may add space, shorten a term, change consideration or reduce scope.

A modification is accounted for as a separate lease when it increases scope by adding the right to use one or more underlying assets and the consideration increases by an amount commensurate with the stand-alone price. Other modifications generally require remeasurement using a revised discount rate, with special treatment when scope decreases. These entries should not be posted as ordinary rent variances.

Current position: In July 2026 the IASB concluded that IFRS 16 is overall working as intended and identified possible future work on remeasurements and discount rates. That decision did not itself amend the current requirements used in this guide.

Lessor accounting in brief

The single lessee model did not remove lessor classification. Lessors continue to classify leases as finance leases or operating leases based on whether substantially all risks and rewards incidental to ownership transfer. This guide concentrates on everyday lessee accounting; a lessor should perform a separate classification and measurement analysis.

Practical lease process

1. Create a central contract register and require procurement legal property and operations teams to flag agreements that may contain an identified asset.
2. Document the lease-identification test, scope conclusion, exemptions, component allocation and lease term before building the schedule.
3. Approve discount rates by currency term asset class security and economic environment, with evidence retained for the reporting date.
4. Lock the approved schedule and control changes through authorised modification or remeasurement forms.
5. Reconcile the schedule to the general ledger, payments, supplier statements and contract register every reporting period.
6. Review renewal decisions, index changes, concessions, impairments, terminations and new contracts before period close.

Common errors

• Looking only at contracts titled lease and missing embedded leases in service arrangements.
• Ignoring a supplier's substantive substitution right or assuming every substitution clause is substantive.
• Using the signed term without assessing extension termination and enforceability.
• Applying a low-value exemption using an arbitrary entity threshold without considering the underlying asset when new.
• Using one unsupported discount rate for every lease.
• Posting payments entirely to rent expense after recognising a lease liability.
• Failing to remeasure for index changes reassessments or modifications.
• Treating the lease schedule as a spreadsheet owned by one person rather than a controlled accounting record.

FGL takeaway

IFRS 16 is a contract-to-ledger control process. The strongest file shows the identified asset, control assessment, enforceable term, payment population, discount rate, present value, journal entries and later changes in one traceable chain. The present-value formula is important, but the judgments feeding it matter more.

Authoritative sources

• IFRS Foundation IFRS 16 Leases - objective, lessee model, effective date and current standard history
• IFRS Foundation IFRS 16 supporting material - official educational material and agenda decisions
• IASB decisions from July 2026 - current status of the post-implementation review and possible future work
• IFRS Foundation IAS 36 Impairment of Assets - impairment of right-of-use assets

Related FGL resources

• Accounting and IFRS

Professional use note

This article is educational and does not replace the complete IFRS Accounting Standards, entity-specific accounting policy analysis, valuation work or professional advice. Apply the requirements to the relevant facts and use the current authorised text of the Standards.

Author: Ivan Lwanga
Publication: Finance & Governance Lab
Last reviewed: 24 October 2026
Jurisdiction: Global - IFRS Accounting Standards