IFRS 16 Lessee Accounting: Full Worked Example with Numbers
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Sai Manikanta Pedamallu
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IFRS 16 Lessee Accounting: Full Worked Example with Numbers
By Sai Manikanta Pedamallu (ACCA, CMA US, CSCA US, CGMA, ACMA, Dip IFRS, M.Com, MBA, MA)
Lead Instructor, Global Fin X | www.globalfinx.in/manikanta
Post 27 covered the conceptual framework of IFRS 16: what qualifies as a lease, what goes on the balance sheet, and why. This post works through the numbers. A complete lessee example from commencement to end, including journal entries, amortisation schedules, a lease modification mid-term, and early termination. All figures are in Indian rupees.
I find that candidates who understand the concepts still lose marks on calculation questions because they have never built the full schedule from scratch. That is what this post is for.
The Base Scenario: Office Lease
Reliance Retail (used for illustration) signs a five-year office lease on 1 April 2024:
- Annual lease payments: Rs. 12 crore, payable in arrears at 31 March each year
- Incremental borrowing rate (IBR): 9% per annum
- Initial direct costs: Rs. 0.30 crore (legal fees)
- No lease incentives received
- No restoration obligation
- Useful life of the underlying asset: 30 years
The implicit rate is not readily determinable, so the IBR of 9% is used.
Step 1: Calculate the Lease Liability at Commencement
The lease liability is the present value of five annual payments of Rs. 12 crore, discounted at 9%.
| Year | Payment (Rs. Cr) | Discount Factor (9%) | Present Value (Rs. Cr) |
|---|---|---|---|
| 1 | 12.00 | 0.9174 | 11.01 |
| 2 | 12.00 | 0.8417 | 10.10 |
| 3 | 12.00 | 0.7722 | 9.27 |
| 4 | 12.00 | 0.7084 | 8.50 |
| 5 | 12.00 | 0.6499 | 7.80 |
| Total | 46.68 |
Lease liability at 1 April 2024: Rs. 46.68 crore
Step 2: Calculate the Right-of-Use Asset at Commencement
ROU asset = Lease liability + Initial direct costs
ROU asset = Rs. 46.68 + Rs. 0.30 = Rs. 46.98 crore
Step 3: Day 1 Journal Entry (1 April 2024)
| Dr (Rs. Cr) | Cr (Rs. Cr) | |
|---|---|---|
| Right-of-use asset | 46.98 | |
| Lease liability | 46.68 | |
| Cash (initial direct costs) | 0.30 |
Step 4: Full Lease Liability Amortisation Schedule
The lease liability unwinds using the effective interest method at 9%.
| Year | Opening Liability (Rs. Cr) | Interest @ 9% (Rs. Cr) | Payment (Rs. Cr) | Closing Liability (Rs. Cr) |
|---|---|---|---|---|
| 1 (FY25) | 46.68 | 4.20 | (12.00) | 38.88 |
| 2 (FY26) | 38.88 | 3.50 | (12.00) | 30.38 |
| 3 (FY27) | 30.38 | 2.73 | (12.00) | 21.11 |
| 4 (FY28) | 21.11 | 1.90 | (12.00) | 11.01 |
| 5 (FY29) | 11.01 | 0.99 | (12.00) | 0.00 |
Rounding differences of a few paise appear in practice. Treat the schedule as illustrative. The critical pattern: interest is front-loaded, declining each year as the liability reduces.
Step 5: ROU Asset Depreciation Schedule
The ROU asset of Rs. 46.98 crore is depreciated straight-line over the shorter of the lease term (5 years) and the useful life of the asset (30 years). Lease term is shorter.
Annual depreciation: Rs. 46.98 ÷ 5 = Rs. 9.40 crore per year
| Year | Opening ROU (Rs. Cr) | Depreciation (Rs. Cr) | Closing ROU (Rs. Cr) |
|---|---|---|---|
| 1 (FY25) | 46.98 | (9.40) | 37.58 |
| 2 (FY26) | 37.58 | (9.40) | 28.18 |
| 3 (FY27) | 28.18 | (9.40) | 18.78 |
| 4 (FY28) | 18.78 | (9.40) | 9.38 |
| 5 (FY29) | 9.38 | (9.38) | 0.00 |
Step 6: Annual Journal Entries (Year 1, FY25)
Interest accrual (31 March 2025):
| Dr (Rs. Cr) | Cr (Rs. Cr) | |
|---|---|---|
| Finance cost (P&L) | 4.20 | |
| Lease liability | 4.20 |
Lease payment (31 March 2025):
| Dr (Rs. Cr) | Cr (Rs. Cr) | |
|---|---|---|
| Lease liability | 12.00 | |
| Cash | 12.00 |
Depreciation (31 March 2025):
| Dr (Rs. Cr) | Cr (Rs. Cr) | |
|---|---|---|
| Depreciation expense (P&L) | 9.40 | |
| Accumulated depreciation – ROU asset | 9.40 |
Year 1 Financial Statement Impact Summary
| Item | Amount (Rs. Cr) | Location |
|---|---|---|
| ROU asset (net) | 37.58 | Balance sheet – non-current asset |
| Lease liability – current | ~8.57 | Balance sheet – current liability |
| Lease liability – non-current | ~30.31 | Balance sheet – non-current liability |
| Depreciation | 9.40 | P&L – operating expenses |
| Finance cost | 4.20 | P&L – finance costs |
| Total P&L charge | 13.60 | |
| Cash paid | 12.00 | Cash flow – financing activities (principal ~7.80) + operating (interest ~4.20, if using that policy) |
The total P&L charge of Rs. 13.60 crore exceeds the cash payment of Rs. 12.00 crore in Year 1. By Year 5, the P&L charge will be lower than the cash payment as interest falls. Total charges over five years equal total cash payments: the timing shifts, not the total.
Current vs non-current split of lease liability:
The current portion is the amount of the liability expected to be settled within 12 months. This is approximated as the next year's payment (Rs. 12 crore) less the next year's interest (Rs. 3.50 crore), giving approximately Rs. 8.50 crore. The non-current portion is the remainder.
Lease Modification: Extension of Lease Term
At the start of Year 3 (1 April 2026), Reliance Retail and the lessor agree to extend the lease by two years, taking the remaining term from three years to five years. The annual payment stays at Rs. 12 crore. The IBR at the modification date is 10%.
This is not a separate new lease: no additional right-of-use is granted and consideration is not commensurate with a standalone price for an additional asset. It is a modification to the existing lease.
Step 1: Lease liability at modification date (before modification)
From the amortisation table, the closing liability at end of Year 2 (31 March 2026) is Rs. 30.38 crore. This is the opening balance for the modification calculation.
Step 2: Remeasure the lease liability using the revised IBR (10%) over the new remaining term (5 years)
| Year | Payment (Rs. Cr) | Discount Factor (10%) | Present Value (Rs. Cr) |
|---|---|---|---|
| 1 | 12.00 | 0.9091 | 10.91 |
| 2 | 12.00 | 0.8264 | 9.92 |
| 3 | 12.00 | 0.7513 | 9.02 |
| 4 | 12.00 | 0.6830 | 8.20 |
| 5 | 12.00 | 0.6209 | 7.45 |
| Revised lease liability | 45.50 |
Step 3: Journal entry at modification date (1 April 2026)
Difference: Rs. 45.50 – Rs. 30.38 = Rs. 15.12 crore increase in lease liability. This is adjusted against the ROU asset.
| Dr (Rs. Cr) | Cr (Rs. Cr) | |
|---|---|---|
| Right-of-use asset | 15.12 | |
| Lease liability | 15.12 |
After modification:
- Lease liability: Rs. 45.50 crore
- ROU asset carrying amount: Rs. 28.18 crore (from depreciation table at end of Year 2) + Rs. 15.12 crore adjustment = Rs. 43.30 crore
Step 4: Revised depreciation
The ROU asset of Rs. 43.30 crore is depreciated over the revised remaining lease term of 5 years.
New annual depreciation: Rs. 43.30 ÷ 5 = Rs. 8.66 crore per year
The modified lease liability is then amortised at 10% over the new five-year term, and the process repeats.
Early Termination: What Happens at Derecognition
Assume instead that at the start of Year 4 (1 April 2027), without any prior modification, Reliance Retail terminates the lease early. The lease agreement requires a termination penalty of Rs. 2 crore.
At termination:
- Lease liability carrying amount: Rs. 21.11 crore (from the original amortisation table at end of Year 3)
- ROU asset carrying amount: Rs. 18.78 crore (from the depreciation table at end of Year 3)
- Termination penalty: Rs. 2.00 crore
Journal entry at termination (1 April 2027):
| Dr (Rs. Cr) | Cr (Rs. Cr) | |
|---|---|---|
| Lease liability | 21.11 | |
| Loss on lease termination (P&L) | 2.78 | |
| Right-of-use asset (net) | 18.78 | |
| Cash (termination penalty) | 2.00 | |
| Accumulated depreciation | 3.11 (plug) |
Let me present this more cleanly:
Derecognise lease liability: Rs. 21.11 crore (credit removed)
Derecognise ROU asset net: Rs. 18.78 crore (debit removed)
Pay termination penalty: Rs. 2.00 crore (cash outflow)
Net: Rs. 21.11 – Rs. 18.78 – Rs. 2.00 = Rs. 0.33 crore gain on termination, recognised in P&L.
The gain arises because the lease liability exceeds the net ROU asset after deducting the penalty. In practice the gain or loss depends on the relationship between these three figures at the termination date. A gain is possible when the liability has unwound faster than the asset has depreciated, which can happen when depreciation is straight-line and interest is front-loaded.
Payments in Advance: How the Numbers Change
The base scenario above uses payments in arrears. Payments in advance change Day 1 mechanics.
If the Rs. 12 crore payment were due at the start of each year (1 April), the first payment is made on the commencement date and is not included in the lease liability. It is included in the ROU asset.
Lease liability = PV of Years 2-5 payments only = PV of four payments of Rs. 12 crore at 9%
= Rs. 12 crore × 3.2397 (4-year annuity factor at 9%) = Rs. 38.88 crore
ROU asset = Rs. 38.88 (lease liability) + Rs. 12 crore (first payment made at commencement) + Rs. 0.30 (initial direct costs) = Rs. 51.18 crore
The total asset is higher because the first year's use is prepaid. The liability is lower because one payment is already made. The income statement pattern is the same: depreciation of Rs. 51.18 ÷ 5 and interest on the declining liability.
In practice, Dip IFRS exam questions specify whether payments are in arrears or advance. Read this carefully: it changes the Day 1 calculation.
Index-Linked Rent: Remeasurement
Suppose the lease in the base scenario includes a clause that rent increases annually by WPI from Year 3 onwards. At the end of Year 2, WPI has increased by 5%, making the new annual rent Rs. 12.60 crore for Years 3-5.
The lease liability must be remeasured at the end of Year 2 using the revised payments and the original IBR of 9% (index changes use the original IBR, not a revised rate).
Revised lease liability at end of Year 2:
PV of three payments of Rs. 12.60 crore at 9%:
Rs. 12.60 × 2.5313 (3-year annuity at 9%) = Rs. 31.89 crore
Previous carrying amount: Rs. 30.38 crore.
Difference: Rs. 1.51 crore increase.
Adjustment:
Dr ROU asset Rs. 1.51 crore
Cr Lease liability Rs. 1.51 crore
The revised ROU asset is depreciated over the remaining three years. The revised liability amortises at 9% over three years with payments of Rs. 12.60 crore.
Index-linked remeasurements use the original IBR. This is different from lease modifications, which use a revised IBR at the modification date. Dip IFRS exams test this distinction.
Disclosure Requirements
IFRS 16 requires lessees to disclose both qualitative and quantitative information enabling users to assess the effect of leases on the financial statements.
Key quantitative disclosures:
Carrying amount of ROU assets by asset class (property, equipment, vehicles) at period end, and depreciation by class for the period.
Interest expense on lease liabilities for the period.
Total cash outflow for leases: principal repayments (financing activities), interest (operating or financing depending on policy), short-term lease payments, and low-value asset lease payments.
A maturity analysis of lease liabilities showing undiscounted cash flows by time band (within one year, one to five years, over five years).
The carrying amount of lease liabilities at the reporting date and movements during the period.
Expenses from short-term leases and low-value asset leases.
Variable lease payments not included in the lease liability.
For Indian IT companies with hundreds of office leases globally, this disclosure note runs several pages. The ROU asset by class (real estate dominates), interest on lease liabilities, and the maturity analysis are all disclosed.
Ind AS 116 vs IFRS 16: Worked Example Differences
There are no material differences in how the numbers are calculated. Ind AS 116 follows IFRS 16's mechanics for lessee accounting identically: same lease liability formula, same ROU asset build-up, same amortisation and depreciation approach, same modification accounting.
The practical differences for Indian entities are:
Lease contracts in Indian rupees naturally use INR IBRs, which are typically higher than USD or EUR IBRs. This means lease liabilities discount more aggressively: the PV of the same rupee cash flows is lower at a 9% IBR than at a 3% EUR IBR.
Indian office leases often include a lock-in period (typically three years) and an option period. Assessing whether the option period is "reasonably certain" to be exercised involves the same factors as under IFRS 16: leasehold improvements made, strategic importance of the location, penalty for not exercising.
What Big 4 Auditors Test in the Numbers
IBR documentation and consistency. Auditors verify that the IBR applied at commencement is supported by a documented methodology. Using the entity's actual borrowing rate from a recent comparable loan is acceptable. Using a rate with no documented basis is not. The IBR must reflect the same currency, similar term, and similar security level as the lease.
Completeness of the lease register. Auditors test whether all leases above the low-value threshold and above 12 months have been captured. Large Indian IT companies have several hundred leases globally. Auditors sample from lease agreements, payables records, and property registers to test completeness.
Modification entries. When leases are modified, auditors check whether a remeasurement has been processed and whether the new IBR has been used. Modifications that should have been treated as separate new leases are tested for correct accounting.
Remeasurement trigger identification. For index-linked leases, auditors check whether rent review dates occurred during the year and whether remeasurements have been processed. Missing a WPI-linked rent review on a large lease portfolio is a known error.
Current vs non-current split accuracy. Auditors recalculate the split of the lease liability between current and non-current and agree it to the balance sheet presentation.
Dip IFRS Exam Angle
The IFRS 16 worked example is one of the highest mark-earning sections in Dip IFRS if done correctly. Most marks come from the schedule, not from narrative.
Build the amortisation schedule correctly:
Opening balance × IBR = interest. Opening + interest – payment = closing. This is the core calculation. Practise it until it is automatic.
Know when to use a revised IBR:
Lease modifications use a new IBR at the modification date. Index-linked remeasurements use the original IBR. Variable payments on exercise of options use the IBR at the reassessment date. This distinction is tested directly.
Payments in advance vs arrears:
In arrears: first payment not made at commencement, so all payments are in the lease liability. In advance: first payment is made at commencement, so it goes into the ROU asset, not the liability.
Modification: separate lease or remeasurement:
A modification is a separate new lease only if it adds the right to use one or more additional underlying assets and the additional consideration is commensurate with the standalone price. Any other modification is a remeasurement of the existing lease.
Termination gain or loss:
Derecognise both the ROU asset (net of accumulated depreciation) and the lease liability. Any termination penalty is a cash outflow. The net of all three items is the gain or loss in P&L.
FAQ
What if the lease payment is monthly rather than annual?
The same mechanics apply. Build the schedule using monthly periods, with the IBR converted to a monthly rate: (1 + annual rate)^(1/12) – 1. Monthly schedules are rarely required in full in exams, but the principle is the same.
Does the IBR change during the lease term?
Generally no. The IBR is fixed at commencement. It only changes on a lease modification or a reassessment event (such as the revision of an index-linked payment, exercising or not exercising an extension option). Each event uses the IBR at that event date.
How is the ROU asset impaired?
If indicators of impairment exist, the ROU asset is tested under IAS 36. The recoverable amount is compared to the carrying amount of the ROU asset. Any impairment reduces the ROU asset carrying amount and goes to P&L. Subsequent depreciation is based on the reduced carrying amount over the remaining useful life.
What happens to the ROU asset at the end of the lease?
Both the ROU asset and the lease liability reach zero at the end of the lease term, assuming all payments are made and no modification has occurred. There is no gain or loss at the natural end of a lease.
Is the lease liability presented gross or net of current portion?
The total lease liability is disclosed, with the current portion (due within 12 months) and non-current portion shown separately on the face of the balance sheet or in the notes.
How does a rent-free period affect the numbers?
A rent-free period does not reduce the number of periods in the lease term. The lease payments across the term are allocated evenly using the EIR method. A two-year rent-free period at the start of a five-year lease means payments of Rs. 0 for years one and two and Rs. 18 crore for years three through five. The lease liability at commencement is the PV of those five cash flows: Rs. 0, Rs. 0, Rs. 18, Rs. 18, Rs. 18. The ROU asset and depreciation follow from that calculation.
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This is Post 28 of the Global Fin X IFRS Series. Previous: IFRS 16: What Goes on the Balance Sheet and Why. Next: Post 29: IFRS 16 Lessor Accounting, Finance vs Operating Leases and Subleases.