Key takeaways
- Under IFRS 16, a lessee recognises almost every lease on the balance sheet: a right-of-use (ROU) asset and a lease liability.
- The liability is the present value of future lease payments, discounted at the rate implicit in the lease or, if that is not readily determinable, the lessee’s incremental borrowing rate.
- Rent expense is replaced by depreciation and interest, which raises EBITDA and front-loads total expense.
- Short-term leases (12 months or less) and leases of low-value assets can be exempted.
Before 2019, most leases of offices, warehouses, factories and vehicles were “operating leases”: the lessee simply expensed the rent, and the obligation for future payments appeared only in a note. IFRS 16 Leases, effective for periods beginning on or after 1 January 2019, changed this for lessees. Lease obligations now sit on the balance sheet alongside other debt, giving lenders and investors a more complete picture of commitments.
For businesses that rent factory buildings, warehouses or showrooms — common across Bangladesh’s manufacturing and retail sectors — the effect on reported assets, liabilities, EBITDA and covenant ratios can be significant. This guide explains how lessee accounting works with a worked example.
1. Is it a lease?
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 conditions must both be met: the customer obtains substantially all the economic benefits from use of the asset, and the customer has the right to direct how and for what purpose the asset is used. If the supplier has a substantive right to substitute the asset, there is no identified asset and no lease. Service contracts — for example, outsourced logistics with unspecified trucks — often fail this test.
2. Initial measurement
Right-of-use asset = Lease liability + payments made at or before commencement + initial direct costs + estimated restoration costs − lease incentives received
Lease payments include fixed payments, variable payments that depend on an index or rate (such as inflation-linked rent), amounts expected under residual value guarantees, and purchase or termination options the lessee is reasonably certain to exercise. Variable payments linked to sales or usage are expensed as incurred. The lease term includes the non-cancellable period plus extension options the lessee is reasonably certain to exercise — a judgement that often has the biggest effect on the numbers.
3. Worked example
A company leases a warehouse for five years at BDT 100,000 per year, paid at the end of each year. The rate implicit in the lease is not known, and the company’s incremental borrowing rate is 10%. There are no initial direct costs or incentives.
Right-of-use asset = BDT 379,079, depreciated straight-line over 5 years = BDT 75,816 per year
| Year | Opening liability | Interest at 10% | Payment | Closing liability | Depreciation | Total expense |
|---|---|---|---|---|---|---|
| 1 | 379,079 | 37,908 | 100,000 | 316,987 | 75,816 | 113,724 |
| 2 | 316,987 | 31,699 | 100,000 | 248,685 | 75,816 | 107,514 |
| 3 | 248,685 | 24,869 | 100,000 | 173,554 | 75,816 | 100,684 |
| 4 | 173,554 | 17,355 | 100,000 | 90,909 | 75,816 | 93,171 |
| 5 | 90,909 | 9,091 | 100,000 | 0 | 75,816 | 84,907 |
| Total | 120,921 | 500,000 | 379,079 | 500,000 |
Illustrative figures. Real leases often have payments in advance, escalations, extension options and restoration obligations that change the calculation.
Swipe sideways to see the full chart →
Lessee expense under IFRS 16 vs cash paid (illustrative, BDT)
View the data behind this chart
| Category | IFRS 16 expense (interest + depreciation) | Cash lease payment |
|---|---|---|
| Year 1 | 113.7k | 100.0k |
| Year 2 | 107.5k | 100.0k |
| Year 3 | 100.7k | 100.0k |
| Year 4 | 93.2k | 100.0k |
| Year 5 | 84.9k | 100.0k |
4. Subsequent measurement
After commencement, the lease liability is measured at amortised cost: increased by interest, reduced by payments. It is remeasured when the lease term changes, when the assessment of a purchase option changes, when expected residual value guarantee payments change, or when index-linked payments change — with a corresponding adjustment to the ROU asset. The ROU asset is normally depreciated on a straight-line basis over the shorter of the lease term and the asset’s useful life (or over useful life if ownership transfers), and is tested for impairment under IAS 36.
5. Impact on financial statements and KPIs
| Area | Before IFRS 16 (operating lease) | Under IFRS 16 |
|---|---|---|
| Balance sheet | Nothing recognised (note disclosure only) | ROU asset and lease liability recognised |
| Income statement | Rent expense within operating costs | Depreciation (operating) and interest (finance cost) |
| EBITDA | Reduced by rent | Higher — rent no longer deducted |
| Total expense profile | Straight-line | Front-loaded in early years |
| Cash flow statement | Rent in operating cash flows | Principal in financing; interest per accounting policy (IFRS 18 changes the options from 2027) |
| Gearing / net debt | Lower | Higher — lease liabilities included |
Because EBITDA rises while net debt also rises, ratios such as net debt to EBITDA can move in either direction. Lenders’ covenant definitions may be “frozen GAAP” (calculated as if IFRS 16 did not exist) or may include lease liabilities — finance teams should check each facility agreement.
6. Practical exemptions
- Short-term leases: lease term of 12 months or less, with no purchase option. Payments can be expensed, applied by class of underlying asset.
- Low-value assets: assets that are low value when new (laptops, small office equipment), applied lease by lease. The IASB’s basis for conclusions referred to a value of around USD 5,000 or less when new as a reference point.
- Non-lease components: lessees can elect, by class, not to separate service components (such as maintenance) from the lease.
7. Making IFRS 16 work in practice
- Build a complete lease register: every rental, hire and service contract that might contain a lease.
- Document lease-term judgements, especially renewal options on factory and warehouse leases.
- Agree incremental borrowing rates with treasury by currency, term and security.
- Use a lease module (SAP RE-FX or a dedicated tool) or a controlled spreadsheet to calculate schedules and monthly journals.
- Review the register at every month-end close for new leases, modifications and terminations.
Standards referenced in this article
IAS and IFRS are one body of standards — IFRS Accounting Standards, issued by the IASB. Standards issued before 2001 keep their IAS numbers and remain fully in force unless replaced. See the full IFRS & IAS standards list for every number and replacement.
| Standard | Title | Status | IFRS # & IAS # link |
|---|---|---|---|
| IFRS 16 | Leases | In force (2019) | Replaced IAS 17 |
| IFRS 18 | Presentation and Disclosure in Financial Statements | Effective 1 Jan 2027 | Replaces IAS 1 |
| IAS 36 | Impairment of Assets | In force | No IFRS number — IAS 36 is the IFRS standard |
Frequently asked questions
What discount rate should be used under IFRS 16?
The interest rate implicit in the lease if it can be readily determined; otherwise the lessee's incremental borrowing rate — the rate it would pay to borrow, over a similar term and with similar security, the funds needed to obtain an asset of similar value in a similar economic environment.
Why does IFRS 16 increase EBITDA?
Operating lease rent was an operating expense deducted before EBITDA. Under IFRS 16 it is replaced by depreciation of the right-of-use asset and interest on the lease liability, both of which are excluded from EBITDA.
Are short-term leases on the balance sheet?
Not if the lessee elects the short-term lease exemption. Leases with a term of 12 months or less and no purchase option can be expensed, generally on a straight-line basis, with disclosure.
Conclusion
IFRS 16 brings leases onto the balance sheet: a right-of-use asset and a lease liability measured at the present value of payments. The mechanics are straightforward once the lease term and discount rate are settled; the effort lies in finding every lease, documenting judgements and keeping the register current. Finance teams should also explain to management and lenders how IFRS 16 changes EBITDA, debt and covenant ratios.
Written by Liakat Hossain
Finance and accounts professional with experience in FP&A, SAP FICO, Power BI, internal control, reporting, audit, tax, VAT and export-oriented business operations.
This article is original educational content based on professional finance practice. Real-project examples are anonymized, and scenario figures are identified as model outputs rather than guaranteed results.