Leases
Leases
First decide whether a lease exists
A contract contains a lease when it conveys the right to control the use of an identified asset for a period in exchange for consideration. Ask:
- Is there an identified asset?
- Does the customer obtain substantially all economic benefits from use?
- Does the customer direct how and for what purpose the asset is used?
A service contract can use supplier assets without giving the customer control of one.
Northstar warehouse
Assume:
- three payments of £24,000 at each year-end;
- three-year lease term;
- 6% discount rate;
- no initial direct costs, incentives or restoration obligation.
Initial lease liability:
Initial right-of-use asset is also £64,152 under these simplified facts.
| Year | Opening liability | Interest at 6% | Cash payment | Principal | Closing liability |
|---|---|---|---|---|---|
| 1 | £64,152 | £3,849 | £24,000 | £20,151 | £44,001 |
| 2 | £44,001 | £2,640 | £24,000 | £21,360 | £22,642 |
| 3 | £22,642 | £1,358 | £24,000 | £22,642 | £0 |
If straight-line depreciation over three years is appropriate, annual right-of-use depreciation is about £21,384.
Build a lease-liability schedule
What changes initial measurement?
The right-of-use asset can include:
- the initial liability;
- payments made at or before commencement;
- eligible initial direct costs;
- estimated restoration obligations;
- less lease incentives.
The liability depends on lease term, enforceable options, fixed or in-substance fixed payments, relevant index/rate payments, residual-value guarantees and the discount rate. Those are judgement points, not spreadsheet inputs supplied by nature.
IFRS and US GAAP do not have the same exemptions
| Topic | IFRS 16 | ASC 842 high-level boundary |
|---|---|---|
| Lessee model | Broad single on-balance-sheet model | Operating and finance lease classifications retained |
| Short-term election | Available when criteria are met | Short-term election available |
| Low-value election | Available for qualifying underlying assets | No general IFRS-style low-value exemption |
| Expense pattern | Depreciation plus interest for ordinary recognised leases | Single lease expense for operating leases; separate interest/amortisation for finance leases |
Cash-flow classification also differs. For IFRS periods before IFRS 18 takes effect, principal is financing and interest follows the IAS 7 policy choice; exempt and liability-excluded variable payments are generally operating. Under US GAAP, operating-lease payments are operating, while finance-lease principal is financing and interest is operating.
Do not carry that IFRS sentence into 2027 mechanically. IFRS 18 applies for annual periods beginning on or after 1 January 2027 and amends specified interest-and-dividend classifications in IAS 7. The contract and measurement stay the same, but the cash-flow presentation must be reassessed under the requirements effective for the reporting period.
Current status
In July 2026 the IASB concluded that IFRS 16 is overall working as intended, while identifying targeted work on application cost, discount rates, remeasurement and rent concessions. These projects do not erase the current model.
Microsoft’s 2025 Annual Report shows why lease notes matter: maturity tables, discount rates, remaining terms and not-yet-commenced commitments can be material even when a single balance-sheet number looks manageable.
Quick check
Why is the year-1 liability reduction £20,151 rather than the £24,000 cash payment?