IFRS 16: 4 Lease Judgements That Trip Up UK Preparers
IFRS 16 requires most leases to be recognised on the lessee’s balance sheet as a right-of-use asset and a corresponding lease liability, replacing the dual operating-versus-finance-lease model that existed under IAS 17. Short-term and low-value leases remain the main exemptions. Getting it right depends on four practical areas: lease term judgements, discount rate selection, remeasurement triggers and disclosure quality.
TL;DR:
Lessees must include most leases on their balance sheet as right-of-use assets and liabilities, with exemptions for short-term and low-value leases.
Lease term judgments depend on economic incentives, not just contractual terms, and require careful documentation of assumptions and remeasurements.
The discount rate should be the lease’s implicit rate if available, or otherwise the lessee’s incremental borrowing rate, with portfolio discounting allowed if consistent.
Disclosures should include lease maturity profiles, significant judgments, and effects on key financial metrics like EBITDA and net debt.
Common pitfalls include misjudging lease terms for rolling contracts, inconsistent application of exemptions, and errors in discount rate calculations or group consolidation entries.
Table of Contents
What counts as a lease under IFRS 16?
A contract is, or contains, a lease when it conveys the right to control the use of an identified asset for a period in exchange for consideration. The standard sets out this test in detail, including how to assess substitution rights and decision-making authority over how and for what purpose the asset is used, under paragraphs B9 to B33.
In practice, many contracts bundle a lease with services, such as a lease of warehouse space that also includes security and maintenance. Preparers need to separate these components unless they elect the practical expedient to account for the whole arrangement as a single lease.
Identify the asset: is it explicitly or implicitly specified, and does the supplier hold a substantive substitution right?
Assess control: does the customer direct how the asset is used and obtain substantially all the economic benefits?
Separate components: split lease payments from service charges using observable standalone prices where available.
Watch hybrid arrangements: equipment-with-operator or managed-service contracts often need careful reassessment as terms change.
Reassessment is triggered by contract modifications, not by a simple change in intention, so document the facts that led to any reclassification.
Recognition exemptions and practical expedients
Two exemptions let lessees keep leases off balance sheet. The short-term exemption applies to leases with a term of 12 months or less at commencement, with no purchase option. The low-value exemption applies to assets that are low value when new, assessed on an absolute basis rather than by reference to materiality for the lessee.
Short-term leases: assess the full lease term, including renewal periods the lessee is reasonably certain to exercise.
Low-value assets: there is no monetary threshold in the standard, so judgement and a documented policy matter.
Vehicles and heavy machinery are generally not considered low value, regardless of their price, according to ICAEW guidance on common pitfalls.
Non-lease components can be combined with the lease by class of underlying asset if elected consistently.
The low-value assessment looks at the underlying asset itself when new, not at the size of the lease payments or its significance to the business, a point HMRC’s business leasing guidance also stresses.
Pro Tip: Keep a one-page register of every low-value and short-term exemption applied, with the reasoning, so your auditor can see the policy was applied consistently rather than reconstructed at year-end.
Initial measurement: lease term, payments and discount rate
Initial measurement starts with the lease term: the non-cancellable period, plus any extension or termination options the lessee is reasonably certain to exercise or not exercise, applying judgement under paragraphs B34 to B41. This judgement should reflect economic incentives, not just contractual notice periods.
Fix the lease term by weighing economic incentives such as leasehold improvements, relocation costs and the importance of the asset to operations.
Build the payment stream from fixed payments, variable payments that depend on an index or rate, residual value guarantees and reasonably certain purchase options, while excluding most variable payments linked to usage or sales and genuine service charges.
Select the discount rate, using the interest rate implicit in the lease where it can be readily determined, or otherwise the lessee’s incremental borrowing rate.
Apply portfolio discounting as a practical expedient for leases with similar characteristics, provided the result does not differ materially from applying the standard lease by lease.
At commencement, the lessee recognises a right-of-use asset and a lease liability measured at the present value of the unavoidable lease payments, per IFRS 16 paragraphs 22 to 26.
Subsequent measurement and remeasurements
After commencement, the right-of-use asset is depreciated, typically on a straight-line basis over the shorter of the lease term and the asset’s useful life, while the lease liability accretes interest using the discount rate set at commencement. Interest expense and depreciation both run through profit and loss, usually above the line that operating lease expense previously sat on under IAS 17.
Remeasure the liability when the lease term changes, when a purchase option assessment changes, or when index-linked or market-rate payments are reassessed.
A remeasurement that increases the liability also increases the right-of-use asset; one that decreases it reduces the asset, with any excess taken to profit or loss.
Lease payments split between a financing outflow (principal) and either an operating or financing outflow (interest), depending on the accounting policy, for cash flow statement presentation under IAS 7.
Keeping a clear audit trail of each remeasurement event, including the trigger and the revised discount rate where applicable, saves significant time at year end.
What disclosures do users of financial statements need?
The disclosure objective in IFRS 16 is to give users enough information to assess the effect of leases on financial position, performance and cash flows, not simply to tick a checklist.
Provide a maturity analysis of lease liabilities and a breakdown of lease expense, including variable payments and short-term or low-value lease costs.
Disclose significant judgements, particularly around lease term and discount rate assumptions.
Lessor disclosures differ from lessee disclosures and depend on whether leases are classified as finance or operating.
Explain the effect on key metrics such as EBITDA, net debt and gearing, since IFRS 16 inflates both assets and liabilities compared with the old operating lease model.
A short narrative alongside the numbers, explaining why leverage ratios moved, helps readers who compare year-on-year trends without wading through the full note.
Common practical pitfalls in applying IFRS 16
Several recurring issues cause the most disputes in practice. Rolling or cancellable leases are a frequent trap: a short notice period does not automatically mean a short lease term if the lessee has a significant economic incentive to continue, a point reinforced in an IASB agenda decision on lease term that looked beyond contractual termination payments to the broader economics of the arrangement.
Don’t assume a rolling lease’s term equals its notice period; assess enforceability, dilapidation costs and fit-out removal costs together.
Document the discount rate methodology clearly, including why portfolio discounting was or was not used.
Check group consolidation entries carefully, since intercompany leases must be eliminated on consolidation even where each entity reports separately.
Review leasehold improvements for impairment triggers whenever a related lease term assumption changes.
Discount-rate selection, rolling leases, recognition exemptions and transition adjustments remain the areas preparers get wrong most often, according to ICAEW’s review of common pitfalls.
Pro Tip: When a lease has a rolling notice period, write down the specific economic reasons the business would stay, not just the contractual minimum, before you finalise the lease term.
How we help clients apply IFRS 16 in practice
We support founders and growing businesses through the parts of lease accounting that cause the most friction: identifying which contracts contain a lease, building the initial measurement workings, and drafting disclosure notes that stand up to audit scrutiny. Our team integrates this work into day-to-day bookkeeping and year-end reporting rather than treating it as a one-off project.
We help you apply the short-term and low-value exemptions consistently, with the documentation an auditor expects to see.
We build and maintain the discount rate and lease term workings as contracts are signed, renewed or modified.
We prepare the disclosure notes alongside your statutory accounts, not as an afterthought.
For UK SMEs working through the related FRS 102 changes, our FRS 102 leases checklist sets out the steps in order.
Where IFRS 16 sits after the IASB’s post-implementation review
The IASB’s July 2026 review found IFRS 16 broadly works, though remeasurements and discount-rate calculations remain costly for lessees. Expect narrow clarifications, not a rebuild of the single lessee model. Document your current policy choices now and track the IASB’s research project.
— Shoaib
Keystone Financial Advisory: support for your IFRS 16 transition and ongoing compliance
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Moving onto IFRS 16 properly means getting the lease register, discount rates and disclosures right from the first reporting period, and keeping them right as leases change. We handle this alongside the rest of your accounting, from bookkeeping through to year-end reporting, so your lease accounting does not sit in isolation from the rest of your numbers.
We review your existing lease contracts and flag which ones need reassessment.
We build the initial measurement and remeasurement workings into your regular reporting cycle.
We prepare disclosure notes as part of your accounts preparation.
Our Flexible Accounting Services offer tiered monthly subscriptions tailored to business size and needs. Get in touch through our services page to discuss a tailored engagement for your lease accounting.
FAQ
What are IFRS 16 leases?
IFRS 16 leases are contracts, or parts of contracts, that convey the right to control an identified asset for a period in exchange for consideration. Under IFRS 16, almost all of these leases are brought onto the lessee’s balance sheet as a right-of-use asset and a lease liability, with short-term and low-value leases as the main exceptions.
What are the four main types of leases?
IFRS 16 itself uses a single lessee model rather than classifying lessee leases into four types. Lessors, however, continue to classify leases as either finance or operating leases, and some practitioners also distinguish short-term and low-value leases as separate practical categories for the exemptions they attract.
Which is the main objective of IFRS 16?
The main objective of IFRS 16 is to ensure lessees and lessors give users of financial statements information that faithfully represents lease transactions, principally by requiring most leases to appear on the balance sheet. This replaced the previous model where operating leases stayed off balance sheet entirely.
How are leases classified under IFRS 16?
For lessees, there is no classification choice: almost every lease is accounted for using the single right-of-use model, aside from short-term and low-value exemptions. Lessors still classify each lease as a finance lease or an operating lease depending on whether substantially all the risks and rewards of ownership transfer to the lessee.
How is the discount rate determined under IFRS 16?
The discount rate is the interest rate implicit in the lease where it can be readily determined, or otherwise the lessee’s incremental borrowing rate. A portfolio approach, applying one rate to a group of similar leases, is permitted as a practical expedient when it does not produce a materially different result.
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