Journal Entries for IFRS 16 Leases (ROU Asset & Lease Liability)
Quick Answer: Under IFRS 16, lessees recognize a right-of-use (ROU) asset and lease liability for virtually all leases. The liability is measured at the present value of lease payments using the lessee's incremental borrowing rate. The ROU asset depreciates over the lease term, while interest accretes on the liability—creating front-loaded expense.
Table of Contents
- Initial Recognition
- Subsequent Measurement
- Interest Accretion
- Depreciation
- Lease Payments
- Full Worked Example
1. Initial Recognition
At commencement, recognize ROU asset and lease liability at the present value of lease payments:
Dr. Right-of-Use Asset — £92,278
Cr. Lease Liability — £92,278
Example: 5-year lease, £20,000/year, incremental borrowing rate 5%
PV = £20,000 × 4.32947 (annuity factor) = £86,589
Plus initial direct costs £5,689 → Total ROU £92,278
2. Subsequent Measurement
After initial recognition, the liability and asset follow different paths:
| Component | Measurement | P&L Impact |
|---|---|---|
| Lease Liability | Amortized cost (interest accretion) | Interest expense |
| ROU Asset | Cost less accumulated depreciation | Depreciation expense |
3. Interest Accretion
The lease liability increases each period by interest, calculated on the opening balance:
Year 1 Interest:
£92,278 × 5% = £4,614
Journal Entry (if not paid):
Dr. Interest Expense — £4,614
Cr. Lease Liability — £4,614
4. Depreciation
ROU asset depreciates over the shorter of lease term or useful life:
Straight-line over 5 years:
£92,278 ÷ 5 = £18,456/year
Dr. Depreciation Expense — £18,456
Cr. Accumulated Depreciation — ROU Asset — £18,456
5. Lease Payments
Each payment reduces the lease liability:
Annual payment of £20,000:
Dr. Lease Liability — £20,000
Cr. Cash — £20,000
Note: This is principal repayment, not expense.
6. Full Worked Example (5-Year Lease)
| Year | Opening Liability | Interest (5%) | Payment | Closing Liability | Depreciation |
|---|---|---|---|---|---|
| 1 | £86,589 | £4,329 | £(20,000) | £70,918 | £17,318 |
| 2 | £70,918 | £3,546 | £(20,000) | £54,464 | £17,318 |
| 3 | £54,464 | £2,723 | £(20,000) | £37,187 | £17,318 |
| 4 | £37,187 | £1,859 | £(20,000) | £19,046 | £17,318 |
| 5 | £19,046 | £954 | £(20,000) | £0 | £17,318 |
Key Point: Total expense is front-loaded (£21,647 Y1 vs £19,272 Y5) due to interest on higher opening liability—unlike straight-line operating lease treatment under IAS 17.
Comparison: IFRS 16 vs IAS 17
| Aspect | IFRS 16 (Current) | IAS 17 (Old) |
|---|---|---|
| Balance sheet | ROU asset + Liability | Off-balance sheet (operating leases) |
| P&L pattern | Front-loaded (higher early expense) | Straight-line |
| EBITDA | Higher (depreciation excluded) | Lower (rent included) |
| EBIT | Lower (depreciation) | Higher |
Short-Term and Low-Value Exemptions
IFRS 16 provides two exemptions kept off-balance sheet:
Short-term leases: Lease term ≤ 12 months
Dr. Rent Expense
Cr. Cash
Low-value assets: New value ≤ US$5,000 (or equivalent)
Same off-balance treatment
