IFRS 16 is the international accounting standard for leases. Its central rule is that a lessee recognises almost every lease on its balance sheet: a right-of-use asset and a lease liability, measured at the present value of the lease payments. It applies to annual periods beginning on or after 1 January 2019 and replaced IAS 17. The only routine exceptions are elective: short-term leases of 12 months or less and leases of low-value assets. For accounting periods beginning on or after 1 January 2026, UK companies on FRS 102 follow a closely aligned lessee model, so the rules now matter well beyond listed groups.
Who applies IFRS 16 in the UK
IFRS 16 applies to any entity reporting under UK-adopted international accounting standards. Section 403(1) of the Companies Act 2006 requires the group accounts of a parent whose securities are admitted to trading on a UK regulated market to be prepared under those standards; other companies may choose them. Subsidiaries and parents can also use FRS 101 in their individual accounts, which applies the recognition and measurement requirements of adopted IFRS with reduced disclosures, so IFRS 16 drives their numbers too.
For everyone else, the 2024 periodic review of FRS 102 rewrote Section 20 for accounting periods beginning on or after 1 January 2026. HMRC's Business Leasing Manual describes it as introducing "the same framework for lessees as IFRS 16". The detail of the FRS 102 version is covered in our guide to lease accounting under FRS 102.
Is it a lease?
Everything starts with the definition. A contract is, or contains, a lease if it "conveys the right to control the use of an identified asset for a period of time in exchange for consideration". Two questions do most of the work:
- Is there an identified asset? A specified asset, or a physically distinct portion of one such as a floor of a building. A capacity portion that is not physically distinct, such as part of the capacity of a fibre optic cable, generally is not an identified asset, and nor is an asset the supplier has a substantive right to substitute throughout the period of use;
- Does the customer control its use? Throughout the period of use the customer must have the right to obtain substantially all the economic benefits from the asset and the right to direct how and for what purpose it is used.
Because the test is about control rather than labels, it can catch service contracts that include a specified asset the customer directs, and it can exclude contracts described as leases that give the customer no control. Once made, the assessment is reassessed only if the terms and conditions of the contract change.
How the lessee accounts for it
At the commencement date the lessee recognises both sides of the entry.
- Lease liability. The present value of the lease payments not yet paid, discounted at the interest rate implicit in the lease if it can be readily determined, otherwise the lessee's incremental borrowing rate. Payments include fixed payments less incentives receivable, variable payments linked to an index or rate, amounts expected under residual value guarantees, a purchase option the lessee is reasonably certain to exercise, and termination penalties where the lease term reflects termination;
- Right-of-use asset. Measured at cost: the initial lease liability, plus payments made at or before commencement less incentives received, plus initial direct costs, plus an estimate of dismantling or restoration costs.
Afterwards the asset is depreciated under IAS 16, normally over the shorter of the lease term and its useful life, and the liability accrues interest at a constant periodic rate and is reduced by payments. The effect is a front-loaded expense profile.
An illustration, with invented figures and rounded amounts: a five-year lease at £50,000 a year paid in arrears, discounted at 5%, gives an opening liability and asset of about £216,474. In year one, depreciation is £43,295 and interest £10,824, a charge of about £54,118 against cash rent of £50,000. By year five the interest has fallen to about £2,381 and the charge to about £45,676. Total expense over the lease still equals total rent; only the timing and the presentation change. Operating profit and EBITDA rise because rent becomes depreciation and interest, and reported debt increases.
The two exemptions
Paragraph 5 lets a lessee elect not to apply the on-balance sheet model to two kinds of lease, expensing the payments on a straight-line or other systematic basis instead:
- Short-term leases. A lease term of 12 months or less at commencement. A lease containing a purchase option is never short-term. The election is made by class of underlying asset;
- Low-value assets. Assessed on the value of the asset when new, on an absolute basis, regardless of how material the leases are to the lessee. The standard's examples include tablet and personal computers, small items of office furniture and telephones. Cars do not qualify, because a new car is not typically of low value. This election can be made lease by lease.
The standard sets no monetary limit for "low value", so groups usually fix one in their accounting policy and apply it consistently.
Lessors, transition and disclosure
Lessor accounting barely changed from IAS 17. A lessor still classifies each lease as a finance lease, if it transfers substantially all the risks and rewards incidental to ownership, or as an operating lease if it does not. The asymmetry means a lease can be on both parties' balance sheets.
On first adoption, IFRS 16 allowed lessees either full retrospective restatement or a cumulative catch-up at the date of initial application. FRS 102 adopters do not get that choice: HMRC's manual notes that "the full retrospective approach available to IFRS reporters cannot be used", although an entity in a group that reports under IFRS 16 can use the carrying amounts from the consolidated accounts.
Disclosure is extensive. Paragraph 53 requires, among other things, depreciation on right-of-use assets by class of asset, interest on lease liabilities, the expense on short-term and low-value leases, variable payments outside the liability, and the total cash outflow for leases. In the cash flow statement, principal repayments sit in financing.
Tax: the accounts change, the deductions largely do not
HMRC's Business Leasing Manual says the same basic principles still apply, with "most rentals being on revenue account despite the on-balance sheet accounting". The manual also notes that while the accounting timing of rentals has changed, the actual cash rentals have not. Where a company first recognised right-of-use assets on adopting a new standard for periods beginning on or after 1 January 2019, Schedule 14 to the Finance Act 2019 requires the transitional adjustment to be spread over the mean average length of the leases that gave rise to it. The long funding lease tests and the corporate interest restriction both need checking separately.
Acumon prepares and audits IFRS financial statements, and we can review your lease population, build the lease schedules and set the policy on discount rates and low-value thresholds. See our IFRS accounts service, or our financial reporting team if you are working through the FRS 102 changes alongside an IFRS group reporting pack.