How to Approach Accounting for IFRS 16 Property Leases

Property leases are where IFRS 16 hits hardest. They tend to be long-term, high-value, and full of complications that other lease types don't have: CPI-linked escalations, embedded leases bundled with service agreements, renewal options that need reassessing every reporting period, and landlord incentives that affect how you measure the ROU asset.

Under IAS 17, most of these sat off the balance sheet as operating leases. IFRS 16 changed that. Now, whether it's a head office, distribution centre, or rented retail unit, you need to recognise both a right-of-use asset and a lease liability for the full term of the agreement.

This article walks through each step: working out whether a contract is in scope, calculating the liability, posting the journal entries, handling remeasurements when terms change, and getting the disclosures right.

Determining if IFRS 16 Applies to Your Lease

The first step is confirming whether your contract is actually a lease under IFRS 16. For a standalone office lease, this is straightforward. But property contracts often bundle services, renewal options, and embedded leases, which makes the assessment less obvious.

Embedded leases occur when a contract that's not explicitly labelled as a lease still grants control over a specific asset, like an office unit, within a broader service agreement. IFRS 16 requires these lease components to be identified and accounted for separately, even if bundled with services like cleaning or maintenance.

Lease Contract Definition

According to IFRS 16, a lease exists if a contract "conveys the right to control the use of an identified asset for a period of time in exchange for consideration." In practical terms, if you're leasing a specific building, floor, or office unit and you have the right to direct its use and derive the economic benefits from it - then yes, you're likely within scope.

To help simplify this decision-making process, we recommend asking three key questions:

1. Is there an identifiable asset? (e.g. "Unit 5, 3rd Floor, 21 Business Street")
2. Do you have the right to control the use of the asset? (Can you decide how and when to use it?)
3. Does the lessor retain any substitution rights? (Can they swap the space out for another unit without your approval?)

If the answer to the first two is "yes," and the third is "no," you're almost certainly dealing with an IFRS 16 lease.

Calculating the Lease Liability and ROU Asset

Once you've confirmed the contract is in scope, the next step is initial recognition: bringing the lease onto your balance sheet. You record two items - a lease liability (your obligation to make future payments) and a right-of-use asset (your right to use the property).

Lease Liability

Under IFRS 16, the lease liability is calculated as the present value of future lease payments, discounted using the appropriate rate. For property leases, this often includes:

• Fixed payments (e.g. monthly rent)
• Variable payments linked to an index (e.g. CPI increases)
• Expected payments under residual value guarantees
• Purchase option payments (if reasonably certain to be exercised)

When it comes to the discount rate, IFRS 16 allows you to use either the interest rate implicit in the lease, or the lessee's incremental borrowing rate (IBR). The IBR is far more common to be used, especially in property agreements where the implicit rate is rarely disclosed.

Variable lease payments based on revenue or performance metrics (such as turnover rent in retail property leases) are excluded from the lease liability calculation. These amounts are recognised as an expense in the period in which the event or condition that triggers the payment occurs.

Right-of-Use Asset

The ROU asset is initially measured at an amount equal to the lease liability, adjusted for:

• Lease payments made before the commencement date (e.g., prepaid rent)
• Any initial direct costs (e.g. legal fees, broker commissions)
• Lease incentives received (which reduce the asset value)

Once recognised, this asset will be depreciated over the lease term. Keep in mind that in practice, it is very common to assess if there is any indicator of impairment for the ROU Asset.

Journal Entries for Property Leases

With the liability and ROU asset calculated, you need to post the entries. The pattern is the same for all IFRS 16 leases, but property leases tend to involve larger amounts, so getting these right matters.

Here's a summary of the most common journal entries:

At Commencement:

Monthly Depreciation:

Monthly Interest:

When Rent is Paid:

Special Considerations for Property Leases

Property leases often include CPI-linked escalations, lease term extensions, or mid-term changes in usage, all of which may trigger lease remeasurements. Specifically considering the CPI-linked escalations, the conclusion that IFRS 16 arrived at is the fact that CPI is too hard to predict, especially over long periods - which is why the CPI impact on the payments are ignored at commencement of the lease.

Remeasuring Lease Liabilities: Property Modifications in Practice

In the real world, property leases are rarely static. A business might renew its lease, downsize its office space, or agree to a rent adjustment due to a CPI escalation or renegotiation. Under IFRS 16, these changes often require lease remeasurement or modification accounting.

Failing to remeasure a lease correctly can lead to material misstatements in both the balance sheet and the income statement.

Common Triggers for Remeasurement or Modification

• Extension or reduction in lease term - Renewing a lease for 3 more years
• Change in expected use of options - Management is now expecting to exercise a purchase or break clause
• Rent change due to CPI or market adjustment - Annual CPI-based rent increase of 6%
• Floor space expansion or reduction - Taking on an extra floor or reducing a part of the property lease
• Change in discount rate (in specific scenarios) - If linked to floating interest rates

How to Recalculate the Lease Liability

Once a triggering event occurs, on that day (the Effective Date):

1. Reassess the lease term and lease payments.
2. Determine the appropriate discount rate.
   • Use the original rate if the change is due to CPI or index adjustments.
   • Use an updated Incremental Borrowing Rate if it's a significant contract change (like extending the lease).
3. Calculate the new present value of the revised payments.
4. Adjust the lease liability accordingly.
5. Make a corresponding adjustment to the right-of-use asset.

Journal Entry Scenarios

Lease liability increases:

Lease liability decreases (by more than the value of the ROU asset carrying value):

When Can You Skip Capitalising a Property Lease? IFRS 16 Exemptions

While IFRS 16 brings nearly all leases onto the balance sheet, it does allow exemptions for leases that are either short in duration or low in value. These simplified accounting treatments are appealing - but when it comes to property leases, it usually is only applicable for short-term property leases.

Short-Term Lease Exemption

Under IFRS 16, a short-term lease is one that:

• Has a lease term of 12 months or less
• Does not include a purchase option

In practice, this might apply to:

• Temporary office rentals
• Pop-up retail locations

If a lease qualifies, the lessee can 'bypass' balance sheet recognition and instead expense lease payments on a straight-line basis over the lease term.

Disclosure Requirements for IFRS 16 Property Leases

Recognising your property leases on the balance sheet is only part of the story. IFRS 16 also sets out a range of disclosure requirements designed to help users of financial statements understand the nature, timing, and uncertainty of your lease obligations, particularly for long-term property leases.

Key Disclosures for Property Leases

• Breakdown of Lease Liabilities - Maturity analysis showing undiscounted lease payments over time
• ROU Asset Movements - Opening and closing balances, additions, depreciation, impairments, and remeasurements
• Lease Expense Types - Short-term, low-value, and variable lease expenses (if applicable)
• Interest Expense - Amount of interest recognised on lease liabilities
• Practical Expedients Applied - Any exemptions used (e.g. low-value or short-term leases)
• Qualitative Disclosures - Nature of leasing activities, extension/termination options

A Quick Tip

When presenting your lease maturity analysis, group the undiscounted payments into categories like:

• Within 1 year
• 1-2 years
• 2-5 years
• Over 5 years

This gives stakeholders a clear view of future obligations tied to your property footprint.

Financial Statement Impacts of IFRS 16 Property Leases

IFRS 16 not only changes how you record leases - it reshapes your financial statements. For companies with property leases, the effects can be substantial, influencing ratios, KPIs, debt covenants, and even investor perception.

1. Balance Sheet Impact

With IFRS 16, you now record:

• A Right-of-Use (ROU) Asset under non-current assets
• A Lease Liability, split between current and non-current liabilities

This increases both sides of the balance sheet, often inflating total assets and liabilities - especially for long-term leases with significant rent payments.

Effect on Key Ratios:

• Debt-to-Equity - Increases (due to higher liabilities)
• Return on Assets - Decreases (due to a larger asset base)
• Current Ratio - May decrease (as most lease liabilities have a short-term portion)

2. Income Statement Impact

Under IFRS 16, you no longer recognise lease payments as a single "rent" expense. They are now separated into two elements:

• Depreciation on the ROU asset
• Interest expense on the lease liability

This results in front-loaded expenses (higher early on), especially for property leases with long terms. It can also improve EBITDA, since interest and depreciation fall below the EBITDA line.

3. Cash Flow Statement Impact

IFRS 16 reclassifies lease payments:

• Principal repayments go to Financing activities
• Interest portion goes to Operating activities
• Short-term/low-value leases remain in Operating activities

Previously, full rent was classified as an operating cash outflow - so this shift improves operating cash flow, while increasing financing outflows.

Managing Property Leases After Day One

The initial recognition is the easy part. Property leases are dynamic - rents escalate, terms get extended, floor space changes - and each of these events triggers accounting work. A few things help keep it manageable.

1. Centralise Lease Data and Documentation

Teams often store lease agreements, addendums, CPI clauses, and renewal terms across emails, departments, and hard drives. Centralising these into a single source of truth, ideally within lease accounting software, makes updates, audits, and disclosures significantly easier.

2. Apply Consistent Discount Rates Where Appropriate

IFRS 16 allows you to use portfolio discount rates for similar classes of assets. This reduces complexity and helps maintain consistency, but ensure the grouping is justified and documented.

3. Stay on Top of Modifications and Remeasurements

Property leases are dynamic. Whether it's a change in rental terms, CPI adjustments, or renegotiation of space, these events usually require remeasurement. Having a clear internal process to flag and evaluate changes is essential.

4. Keep an Audit Trail

Auditors will review journal entries alongside payment schedules, assumptions, and contracts. Every figure needs to be traceable to its source. If you're using spreadsheets for a portfolio of more than a handful of property leases, this is where things tend to break down - version control, formula errors, and missing documentation are common audit findings.

The Bottom Line

Property leases are the most complex lease type under IFRS 16. They're long-term, they change frequently, and they carry the largest balance sheet impact. Getting the initial recognition right is straightforward enough, but it's the ongoing work - CPI escalations, term reassessments, modification accounting - that catches teams out.

The finance teams that handle this well are the ones with clean lease data, clear internal processes for flagging changes, and systems that can handle remeasurements without manual rework. The ones that struggle are typically still running everything through spreadsheets that were built for the initial transition and never updated.