Easier than you think - IFRS 16: Lessee Initial Recognition

Written By Robert Harrison

Lessee Accounting is quite expansive when trawling through the content of IFRS 16. Having now been implemented to FRS102 since 1st January 2026 a lot of UK businesses are now sitting with the headache of adopting this new inflated balance sheet.

Well, our late adopters at any rate.

In aid of their, and possibly your, struggle I thought it may be helpful to put together a quick introductory guide on getting IFRS 16 compliant.

For readers who are perhaps a bit more time poor I recommend referring to chapter B31 of IFRS 16 where the assessment flowchart has been buried.

a) Identifying the lease

Now as much as I wish this were some kind of game it really isn’t. IFRS 16 goes over a number of criteria as to whether a lease is a lease by definition but the things to watch out for by and large are as follows:

  • You contractually gain the right to use a specific asset. (Referred to as the right of use asset)

  • That asset cannot be substituted by the lessor.

  • You have full control over how the asset is used. Barring any deliberate action undermining the lease of course, so no blowing up that leased truck for movie production.

  • The rights to the asset are for the period of the lease.

  • You contractually gain the right to most of the income generated by use of the asset (Referred to as economic benefits rather income in the IFRS to cover items that may be more ambiguous)

  • This is all in exchange for consideration.

Now that’s not IFRS 16 verbatim buts its much more easily digestible.

b) The lease term

This is the most likely combination of:

  • The non-cancellable lease term

  • Options to extend the lease term

  • Options to cancel the lease term

Review this on changes to intention or to the lease itself.

c) Initial measurement of the lease liability

This is where the bulk of confusion and errors come about with this IFRS so its a good part to slow down and take some notes.

At the date the right of use asset is made available to the lessee must recognise all unpaid lease payments for the term of the lease as at that same date.

These include:

  • fixed payments (or in-substance fixed payments) less incentives

  • variable lease payments linked to indexes or markets (Good luck)

  • Residual value guarantees expected to be payable by the lessee

  • Purchase price options expected to be exercised

  • Termination penalties expected to be incurred

Now that is mostly simple enough to recognise and total, however these payments need to be discounted to present value using either:

  • The interest rate implicit to the lease (Determined by running IRR on the leases cashflows from the lessor’s perspective. Good to note that PV needs to equal fair value of the asset + lessor’s directly attributable costs).

    OR if the above cannot be determined

  • The lessee’s incremental borrowing rate.

Now if you’re able to find a lessor who is readily willing to share the intimate details of how they’re making a tidy profit off you then this is actually incredibly simple.

In the more likely scenario where your lessor plays their cards close to the chest you now have more work to do.

You essentially need to ascertain the borrowing rate applicable to the lessee if they were to purchase the asset via finance using the asset as collateral for the loan, which quite frankly is it’s own dull article.

d) Initial measurement of the right of use asset

This is the final round off for initial measurement is your non-current counterpart to the lease liability determined above.

This value is much easier to determine as you’ve done most of the heavy lifting in determining the present value of your lease liability. It comprises as follows:

  • The value of the initial measurement of the lease liability

  • PLUS: Lease payments made before or at the commencement date

  • LESS: Lease incentives received

  • PLUS: Lessee initial direct costs

  • PLUS: Estimates of dismantling & removing the assset

  • PLUS: Costs to restore the installation site to the condition specified by the lease terms

e) Journal

Dr Right of use asset (Equal to the lease liability)

Cr Lease liability (As determined through appropriate discounting)

Dr Right of use asset (Payments made at or before the commencement date)

Cr Cash

Dr Cash (Lease incentive received)

Cr Right of use asset

Dr Right of use asset (Dismantling and removal estimate discounted per IAS 37)

Cr Provision

Dr Right of use asset (Site restoration estimate discounted per IAS 37)

Cr Provision

References

Alliotts. (2025) Changes to Lease Accounting under FRS 102: IFRS 16 Comes to UK GAAP. Available at: https://www.alliotts.com/articles/changes-to-lease-accounting-under-frs-102-ifrs-16-comes-to-uk-gaap/ (Accessed: 17 February 2026).

EY. (2018a) Leases: Determining the Incremental Borrowing Rate in Practice. Available at: https://www.ey.com/en_sa/media/podcasts/2018/11/leases-determining-the-incremental-borrowing-rate-in-practice (Accessed: 17 February 2026).

EY. (2018b) Use of the Interest Rate Implicit in the Lease and the Incremental Borrowing Rate. Available at: https://www.ey.com/en_sa/media/podcasts/2018/11/use-of-interest-rate-implicit-in-the-lease-and-incremental-borrowing-rate (Accessed: 17 February 2026).

IFRS Foundation. (2025) IFRS 16: Leases. Available at: https://www.ifrs.org/issued-standards/list-of-standards/ifrs-16-leases.html (Accessed: 17 February 2026).

Financial Reporting Council (FRC) (2024) FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland (September 2024). Available at: https://www.frc.org.uk/library/standards-codes-policy/accounting-and-reporting/uk-accounting-standards/frs-102/ (Accessed: 17 February 2026).

Official IFRS: IFRS Foundation (2022) IAS 37 Provisions, Contingent Liabilities and Contingent Assets. Available at: https://www.ifrs.org/issued-standards/list-of-standards/ias-37-provisions-contingent-liabilities-and-contingent-assets/ (Accessed: 17 February 2026).

Robert Harrison