TL;DR

IFRS 16 lease accounting puts almost every lease on the balance sheet as a right-of-use asset and a lease liability. It replaced IAS 17 in 2019 and ended the old operating-versus-finance split for lessees. This guide walks through lessee and lessor treatment, the lease liability calculation, journal entries, the EBITDA and ratio effects, and how auditors test it, with worked numbers for UAE and Saudi leases.

IFRS 16 lease accounting is the rule that moved operating leases out of the footnotes and onto the balance sheet. Since 1 January 2019 a lessee recognises a right-of-use asset and a lease liability for almost every lease, so rent that used to be a single line in the income statement now shows up as depreciation plus interest. If you sign office space in Dubai, forklift contracts in Riyadh, or a vehicle fleet in Karachi, this is the standard that decides how those contracts hit your accounts.

The change was not cosmetic. When the standard landed, reported assets rose by roughly 5% and liabilities by about 9% across affected companies. Whole debt ratios moved overnight, without a single new loan being signed.

So the real question is not what IFRS 16 says. It is what it does to your numbers, and where auditors push back. That is what the rest of this guide covers.

What is IFRS 16 lease accounting?

IFRS 16 is the accounting standard that requires lessees to recognise most leases on the balance sheet as a right-of-use asset and a matching lease liability, measured at the present value of future lease payments. It took effect on 1 January 2019 and replaced IAS 17.

Before that, operating leases sat off balance sheet. A five-year office lease was just rent, expensed as you paid it, invisible to anyone reading the balance sheet. The IASB decided that hid too much. Investors were comparing two companies with the same real obligations and seeing wildly different debt levels, purely because one leased and one borrowed to buy.

So IFRS 16 collapsed the distinction. For a lessee, there is now one model: recognise the asset, recognise the liability, then run depreciation and interest through profit or loss. That is the whole idea. Everything else is detail.

What the standard set out to do:

• Bring lease obligations into plain view on the balance sheet
• Make a company that leases comparable to one that borrows and buys
• Give lenders and investors the real commitment number, not a footnote estimate
• Kill the operating-versus-finance lease arbitrage for lessees

For quick answers aimed at non-finance teams, our IFRS 16 lease FAQs cover the same ground with fewer numbers.

What counts as a lease under IFRS 16?

A contract contains a lease if it gives you the right to control the use of an identified asset for a period, in exchange for payment. Two tests decide it: is there an identified asset, and do you control how it is used?

Is there an identified asset?

The asset has to be specified, either explicitly or by being the only one that fits. If the supplier can swap it out for another whenever they like, and it benefits them to do so, there is no identified asset and no lease.

Do you control how it gets used?

Control means two things at once: you take substantially all the economic benefit from using the asset, and you direct how and why it is used across the contract.

Here is where it gets practical. You sign a five-year deal for the 10th floor of a tower in Dubai. The floor is specified, you decide how to run the space, you get the benefit. That is a lease. Now compare a cloud hosting contract where the provider shuffles your workload across servers you never see. No identified asset, so usually no lease. Same monthly invoice, completely different accounting.

The grey zone is contracts that bundle an asset with a service, shared assets, and supplier substitution rights. Those need judgment, and they are exactly the ones auditors circle first.

What IFRS 16 leaves out

Some contracts look like leases and are not. Others are leases that the standard deliberately sends somewhere else.

Five categories sit outside the scope of IFRS 16 lease accounting entirely:

• Leases of intangible assets, which fall under IAS 38
• Biological assets, covered by IAS 41
• Service concession arrangements inside IFRIC 12
• Licenses of intellectual property granted by a lessor, which IFRS 15 handles
• Rights to explore for or use oil, gas, minerals and other non-regenerative resources, where industry guidance takes over and the lease question never really starts

The harder problem is the service contract that feels like a lease. A freight deal where the carrier picks the truck and plans the route is a service. So is a hosting agreement where you never learn which machine ran your job.

Bundled contracts are messier again. Office space that arrives with cleaning and maintenance holds a lease component and a service component, and you split the consideration by stand-alone price. IFRS 16 lets you skip the split and treat the whole payment as lease. That is convenient, and it inflates both the right-of-use asset and the liability, which feeds straight into your debt-to-equity and debt-to-assets ratios.

Our position: separate the components whenever the supplier already prices the service line on the invoice, because the data is sitting right there. Take the expedient only where the service element is a rounding error, like maintenance bundled into a small vehicle fleet. If the revenue side of these bundled deals is also on your desk, our walkthrough of IFRS 15 revenue scenarios covers the mirror-image judgment.

And if you cannot decide whether a contract is a lease at all, that hesitation is worth writing down. The auditor will reach the same fork six months later and ask what you concluded.

How is IFRS 16 different from IAS 17?

Under IAS 17, lessees sorted every lease into one of two buckets. Operating leases stayed off balance sheet and hit the income statement as straight-line rent. Finance leases went on balance sheet. Two models, and a strong incentive to structure deals so they landed in the off-balance-sheet bucket.

IFRS 16 removed the choice for lessees. Here is the before and after:

A 2025 study of listed mining companies found IFRS 16 adoption materially shifted debt-to-equity and debt-to-assets ratios, while return on assets barely moved. So the debt picture changed, the profitability picture mostly did not.

What IFRS 16 swept away

IAS 17 did not go quietly on its own. IFRS 16 also killed IFRIC 4 on whether an arrangement contains a lease, SIC-15 on operating lease incentives, and SIC-27 on transactions dressed up in the legal form of a lease. Four pieces of guidance, replaced by one model.

The scale of what was hidden explains why. Under IAS 17, around 85% of lease contracts were classified as operating and stayed off the balance sheet. Not a rounding error. That was the majority of corporate leasing, sitting in a note that most readers skipped.

[Image Placeholder: Balance sheet before and after IFRS 16 adoption]

Those SIC-27 style structures are worth remembering, because the instinct behind them never died. It just moved to lease-term judgments and discount rates. For what the board is working on now across the standards, see our summary of IASB updates for 2026.

How do lessees account for a lease under IFRS 16?

At the start date, a lessee records a lease liability at the present value of unpaid lease payments, and a right-of-use asset at that same amount plus a few add-ons. After that, the liability accrues interest and reduces as you pay, while the asset depreciates.

Step 1: measure the lease liability

The liability is the present value of what you are committed to pay. That includes fixed payments, index-linked variable payments, residual value guarantees, a purchase option price if you are reasonably certain to exercise it, and any termination penalties baked into the term.

Step 2: pick the discount rate

Use the rate implicit in the lease if you can work it out. Usually you cannot, so you fall back on your incremental borrowing rate, the rate you would pay to borrow the money to buy a similar asset in the same economy for the same period. This one number drives the whole liability, and it is the assumption auditors question most.

Step 3: build the right-of-use asset

The ROU asset starts at the liability amount, plus prepaid lease payments, plus your initial direct costs, plus any estimated cost to dismantle and restore the asset at the end. Then you depreciate it straight-line over the shorter of the lease term and the asset’s useful life.

A worked example: Dubai office lease

Take a real-shaped case. Annual rent of AED 500,000, five-year term, incremental borrowing rate of 6%, legal fees of AED 25,000, security deposit of AED 100,000.

The present value of AED 500,000 a year for five years at 6% is AED 2,106,178. So:

• Lease liability = AED 2,106,178
• Right-of-use asset = 2,106,178 + 25,000 + 100,000 = AED 2,231,178

Initial entry:

Dr Right-of-use asset 2,231,178
Cr Lease liability 2,106,178
Cr Cash (legal fees) 25,000
Cr Cash (deposit) 100,000

First annual payment, split into interest and principal:

Dr Lease liability 390,456
Dr Interest expense 109,544
Cr Cash 500,000

Interest is the opening liability times 6%. Depreciation runs separately, AED 37,186 a month across 60 months. Notice the shape: early years carry more interest, so total expense is front-loaded compared with the old flat rent. That front-loading is the single most misread feature of IFRS 16 lease accounting, and it is where finance teams get caught out at year one.

Want the full amortisation schedule with every period broken out? Our 10-point IFRS 16 lease checklist lays out the calculation steps in order.

Two more worked examples: retail and aviation

The Dubai case above uses payments in arrears. Change the industry and the payment timing, and the numbers behave differently enough to be worth showing.

Retail storefront, 10 years. Annual rent of 100,000, paid at each year end, incremental borrowing rate of 5%. The present value is 772,173, so that is both the opening liability and the opening ROU asset. Depreciation runs at 77,217 a year. Year one interest is 38,609, giving total expense of 115,826 against a cash payment of 100,000. By year ten the liability has shrunk to 95,238 at the start of the period, interest falls to 4,762, and total expense drops to 81,979. Same store, same rent, expense curve sloping down by roughly a third.

Aircraft, 12 years, paid in advance. Annual payments of 5,000,000 at the start of each year, implicit rate 4%. Because the first payment lands on day one, this is an annuity due. The opening liability is 48,802,385, of which 5,000,000 is settled immediately, leaving 43,802,385 to accrue interest. Year one interest is 1,752,095 and depreciation is 4,066,865.

Here is the trap. Model that aircraft lease as if payments arrive at year end and you get 46,925,370, understating the asset and the liability by about 4%. On a fleet of twenty aircraft, that gap is real money and a real disclosure error.

[Image Placeholder: Calculating the lease liability in practice]

Spreadsheets handle ten leases. At two hundred, payment timing errors like this one stop being visible, which is the point at which most teams look at automating IFRS 16 calculations.

Leasehold improvements, deferred rent and restoration costs

Three items sit next to the ROU asset and get mixed into it by mistake more often than any other part of the standard.

Leasehold improvements stay separate. Your fit-out, partitions and cabling are your own assets under IAS 16, depreciated over the shorter of their useful life and the lease term. Spend AED 2 million fitting out a floor on a five-year lease and you write it off across five years, not the fifteen the fit-out might physically last. Unless you are reasonably certain to renew, which loops straight back to the lease-term judgment from earlier, and shows why that single call moves more numbers than people expect.

Deferred rent is gone for lessees. It existed because IAS 17 spread uneven rent straight-line and parked the difference on the balance sheet. With one model and an amortised-cost liability, there is nothing left to defer. Rent-free periods now simply reduce the payments you discount.

Restoration and dilapidation costs do belong in the ROU asset. Estimate the cost of stripping out and reinstating at commencement, add it to the asset, and recognise the matching provision under IAS 37. Then revisit it when the estimate changes, which for GCC office space it usually does.

One more thing people skip: ROU assets are inside the scope of IAS 36. A store you have stopped trading from still carries an asset that needs testing, and our guide to IAS 36 impairment testing covers how that assessment runs.

How do lessors account for leases under IFRS 16?

Lessor accounting barely changed. If you are the one leasing an asset out, you still classify each lease as either a finance lease or an operating lease, exactly as you did under IAS 17, based on whether you pass substantially all the risks and rewards of ownership to the lessee.

Finance leases

You transfer the risks and rewards, so you take the asset off your books and recognise a net investment in the lease instead. Interest income runs over the term using the effective interest method. Ownership passing at the end, a bargain purchase option, a term covering most of the asset’s life: any of these points to a finance lease.

Operating leases

You keep the risks, so you keep the asset on your balance sheet, keep depreciating it, and recognise lease income straight-line. The only real shift from IAS 17 is heavier disclosure, so users can see your leasing exposure.

Subleases: lessee and lessor at the same time

Sublet part of your floor and you are running two sets of lease accounting at once. The head lease stays exactly where it was, on your books as lessee. The sublease gets lessor treatment.

The classification rule is the one that surprises people. You assess the sublease against the right-of-use asset from the head lease, not against the building itself. So a sublease can be a finance lease even though you have never owned a square metre of the property. Pass on substantially all the benefit of your ROU asset for most of its remaining term, and it is a finance lease.

That has a consequence worth pausing on. As intermediate lessor you derecognise the ROU asset, book a net investment in the sublease, and keep the head lease liability sitting on your balance sheet. Gross up, not net off.

One exception: if the head lease is a short-term lease where you took the recognition exemption, the sublease is an operating lease by default. There is no ROU asset to transfer.

This matters more in the GCC than the textbooks suggest, because holding companies routinely sign one master lease and recharge floors to subsidiaries. Intragroup subleases wash out on consolidation. They do not wash out of the standalone statutory accounts each entity files with its regulator, and that is where the surprise usually lands. Prima’s IFRS 16 advisory services cover exactly this kind of group-structure review.

Sale and leaseback under IFRS 16

You sell your head office and lease it back for fifteen years. Cash lands, the building leaves. What does the accounting do?

First test whether a sale actually happened, using the transfer-of-control rules in IFRS 15. If control passed, you derecognise the building and recognise a ROU asset measured at the proportion of the previous carrying amount that relates to the rights you kept. Gain or loss goes only on the portion transferred to the buyer.

That last part is the one that disappoints finance directors. Sell a building carried at 40 million for 60 million and lease back rights worth two thirds of it, and you do not book a 20 million gain. You book the share of it that matches the rights you genuinely gave up.

If control never passed, and buyback options are the usual reason, there is no sale. You keep the asset, recognise the proceeds as a financial liability under IFRS 9, and the whole thing behaves like secured borrowing. Which, commercially, it was.

The 2022 amendment on variable payments in a leaseback tightened this further from 2024. A seller-lessee measures the leaseback liability so that no gain is recognised on the retained rights, and variable payments get pulled into that measurement rather than expensed as they arise. Our note on IFRS 15 revenue recognition fundamentals sets out the control test the whole assessment hangs on.

Run the sale test before you sign, not after. The commercial terms decide the answer, and by the closing date they are fixed.

What are the exemptions under IFRS 16?

Lessees can skip the on-balance-sheet treatment for two kinds of lease: short-term leases and low-value leases. Both are optional, and you elect them.

Short-term leases run 12 months or less with no purchase option. You count from the start date, ignore extensions you are not committed to, and just expense the payments straight-line. A rolling 11-month equipment rental in Riyadh with no buyout qualifies.

Low-value leases cover assets worth roughly USD 5,000 or less when new. Laptops, phones, small office furniture. Cars, trucks and machinery do not qualify, however cheap the monthly cost looks, because you judge value on the new asset, not the payment.

Most teams elect both. Tracking a full ROU schedule for a stack of tablets is not worth the effort, and the standard knows it.

How does IFRS 16 affect the balance sheet, EBITDA and key ratios?

IFRS 16 lifts reported assets and liabilities, raises EBITDA, and front-loads total expense. Cash does not change at all, but almost every ratio built on these numbers does, which is why lenders and analysts had to relearn how to read leased-heavy companies.

Balance sheet

Right-of-use assets appear inside property, plant and equipment. Lease liabilities split into current and non-current. For most companies total assets rise 3% to 8%, but retail, airlines and restaurants sit far higher because their whole model runs on leased space.

EBITDA and the income statement

This is the effect people underestimate. Old operating-lease rent sat above EBITDA. Under IFRS 16 that rent splits into depreciation and interest, both below EBITDA. So EBITDA jumps, even though nothing about the business improved. “ifrs 16 impact on ebitda” is one of the most searched questions on this standard for exactly that reason, and if you report to lenders on an EBITDA covenant, the jump matters. We break the mechanics down in detail in our guide to the IFRS 16 impact on business KPIs.

Operating profit, meanwhile, tends to dip in early years because of the front-loading, then recover later. Total expense over the full term is roughly the same as before. It is the timing that moves.

Cash flow

Total cash out is identical. What changes is where it sits. The principal part of each payment moves from operating activities down to financing. Interest usually stays in operating. So operating cash flow looks stronger under IFRS 16 purely from reclassification, which flatters any operating-cash-to-debt metric if you do not adjust for it.

What do auditors check in IFRS 16 lease accounting?

Auditors focus on the assumptions that move the numbers most: the discount rate, the lease term, and whether embedded leases inside service contracts got picked up at all. Get those three wrong and the whole liability is wrong.

The recurring audit findings we see across GCC engagements cluster in a few places:

1. Discount rate that cannot be defended. A single group rate slapped on every lease, with no build-up from a risk-free base, no credit spread, no adjustment for term. Auditors want the workings, not just the answer.
2. Lease term that ignores renewal reality. If you have poured money into fit-out or the site is strategic, “reasonably certain to renew” probably applies, and leaving the option period out understates the liability.
3. Embedded leases missed entirely. A logistics or IT service contract that hands you a specific, controlled asset is a lease, even though the contract never says the word.
4. Modifications handled as if nothing happened. Rent renegotiations and scope changes need remeasurement, and the mechanics trip people up. Our guide to IFRS 16 lease modification accounting works through when to remeasure versus treat a change as a separate lease.

Disclosure is the other soft spot. In the early years of the standard, entities complied with only 58% of disclosure requirements. The maturity analysis of lease liabilities and the split of ROU assets by class are the lines most often left thin.

The audit procedures your auditor actually runs

Knowing what gets tested is more useful than knowing what gets criticised. IFRS 16 audit procedures follow a fairly predictable sequence, and you can run most of them yourself before fieldwork starts.

Completeness comes first. The audit team reconciles your lease register to the rent expense ledger, the property register and the vendor payments file, then samples service contracts looking for embedded leases nobody flagged. If a supplier invoice recurs monthly at a flat amount, expect it to be pulled.

Then accuracy. They recalculate the present value on a sample of leases, agree the payment schedule and dates back to the signed contract, and rebuild your discount rate from its components. A rate that arrived by email from treasury with no build-up will not survive that step.

Judgment testing follows. Lease terms get challenged against fit-out spend, renewal history and board plans. Modifications during the year get traced to remeasurement entries. Terminations get checked for the gain or loss on derecognition.

Last comes presentation: the maturity analysis, the ROU asset split by class, and the roll-forward of both balances tying to the general ledger.

Where cross-border groups run into trouble is dual reporting, because the US test is a different one. The differences are set out in our comparison of IFRS 16 vs US GAAP leases. Pull that sample yourself in October and you get to fix things quietly.

Which transition option should you have used?

IFRS 16 offered two routes at adoption, and the choice still shows up in comparatives today. Full retrospective restates every prior period as if the standard had always applied. Modified retrospective applies it from 1 January 2019 with no restatement, using practical expedients to cut the work.

Most companies took the modified route. It is cheaper, faster, and the expedients (one discount rate across a portfolio of similar leases, hindsight on lease terms, skipping the lease-versus-service reassessment) remove a lot of pain. The trade-off is weaker year-on-year comparability, which you disclose. If you were data-rich and comparability mattered to your investors, full retrospective was the cleaner story. Almost nobody chose it.

How to implement IFRS 16 without the usual mess

Implementation fails on data, not on theory. Teams understand the accounting fine; they discover halfway through that nobody has a clean, complete inventory of the lease contracts. Start there.

A sequence that works:

1. Inventory every lease and lease-like arrangement, including embedded ones in service contracts
2. Run each contract through the identified-asset and control tests to confirm it is in scope
3. Pull the terms that drive the numbers: payments, dates, options, discount rate inputs
4. Pick a calculation approach, spreadsheet or software, and validate it on a handful of leases before scaling
5. Write the policy down, document the judgments, and set a process for new leases so year two is not another fire drill

The last point is the one people skip. IFRS 16 is not a one-off project. Every new lease, every modification, every renewal feeds the model, so the standard needs an owner and a repeatable process, not a heroic year-end scramble. For companies that would rather hand the mechanics to a specialist, Prima’s IFRS 16 lease accounting service covers scoping through to audit support.

The IASB is reviewing IFRS 16 right now

Standards do not stay frozen. In June 2025 the IASB opened its Post-Implementation Review of IFRS 16, asking preparers, auditors and investors what has worked and what has not since 2019.

The topics under the microscope are the ones this guide keeps circling back to. Lease term and how firms judge renewal options. Discount rates when no implicit rate exists. Variable payments that sit outside the liability. And the volume of disclosure, which preparers call heavy and investors call thin, which tells you how far apart those two groups still are.

A word of caution on timing. The IFRS 15 review took years to move from questions to amendments, so nothing here will change your December close, or the one after that. Anyone telling you to pause a remediation project until the board reports is giving you a reason to do nothing.

So fix the discount rate file now. Fix the embedded lease sweep now. If an amendment lands in 2028 that softens a requirement, you will have lost nothing, because the documentation an auditor wants today is the same documentation any revised standard will want tomorrow. For the wider picture of what is changing across the standards this year, see our roundup of IFRS changes in the 2026 update.

Frequently asked questions about IFRS 16 lease accounting

Does IFRS 16 apply to all leases?

Almost all. A lessee brings every lease onto the balance sheet except two elective exemptions: short-term leases of 12 months or less with no purchase option, and low-value leases of assets worth around USD 5,000 or less when new. Everything else gets a right-of-use asset and a lease liability.

How does IFRS 16 affect EBITDA?

EBITDA goes up. Under the old rules, operating-lease rent sat above EBITDA as an expense. IFRS 16 replaces that rent with depreciation and interest, both of which fall below EBITDA. So EBITDA rises without any change to the underlying business, which matters if you report against an EBITDA-based loan covenant.

What discount rate do you use under IFRS 16?

Use the interest rate implicit in the lease if you can determine it. Most of the time you cannot, so you use your incremental borrowing rate: what you would pay to borrow funds to buy a similar asset, over a similar term, in the same economic environment. In the GCC that usually means building up from SAIBOR or EIBOR plus a credit spread.

When did IFRS 16 become mandatory in the UAE and Saudi Arabia?

1 January 2019, the same global effective date. UAE mainland companies preparing IFRS statements apply it, and Tadawul-listed companies in Saudi Arabia comply under SOCPA guidance. Free zone entities may sit under a different framework, so check your specific regulatory basis before assuming it applies.

How do lessors differ from lessees under IFRS 16?

Lessees follow one on-balance-sheet model for nearly every lease. Lessors kept the old two-way split: classify each lease as a finance lease or an operating lease based on who holds the risks and rewards of ownership. So the standard reshaped lessee accounting far more than lessor accounting.

Where IFRS 16 lease accounting leaves you

The mechanics are learnable in an afternoon. Present-value the payments, book the asset and the liability, run depreciation and interest, watch the front-loading in year one. What actually decides whether your numbers survive an audit is the judgment layer underneath: the discount rate you can defend, the lease term you can justify, the embedded leases you did not miss.

If any of those three feel shaky on your current book, that is the place to look first, before year-end, not during it. Prima’s team runs IFRS 16 scoping, calculation, and audit-defence work across Saudi Arabia, the UAE, Pakistan and Europe. Send us the contract that is giving you trouble and we will tell you how it should land.