Key Points
- IFRS 16 eliminated the operating lease classification for lessees; every lease (with narrow exceptions) now produces a balance sheet asset and liability.
- The short-term and low-value exemptions in IFRS 16.5 spare leases under 12 months or below approximately EUR 5,000 from on-balance-sheet treatment.
- Total expense over the lease term is identical under both models, but IFRS 16 front-loads the charge because interest accretes on a declining liability.
- Lessors still classify leases as operating or finance under IFRS 16.61-66, so the old distinction survives on one side of the contract.
Side-by-side comparison
| Dimension | IFRS 16 right-of-use asset model | IAS 17 operating lease model |
|---|---|---|
| Balance sheet recognition | Lessee recognises a right-of-use asset and lease liability at commencement (IFRS 16.22) | No asset or liability; the lease disclosed only in the notes (IAS 17.35) |
| P&L expense pattern | Depreciation of the right-of-use asset plus interest on the lease liability; total charge is front-loaded in early years | Straight-line rental expense over the lease term (IAS 17.33) |
| Effect on EBITDA | Lease payments no longer sit in operating expenses; EBITDA increases because only depreciation (below EBITDA) and interest appear | Lease payments reduce EBITDA directly as operating expenses |
| Key ratios affected | Gearing, return on assets, and net debt all increase; interest cover decreases | Ratios unaffected by lease obligations that remain off balance sheet |
| Classification test for lessees | No classification required; one model applies to all leases (with short-term and low-value exemptions) | Lessee classifies each lease as operating or finance based on risks-and-rewards criteria in IAS 17.10 |
| Transition mechanism | Modified retrospective or full retrospective approach under IFRS 16.C5-C8 at 1 January 2019 | Not applicable (IAS 17 was the predecessor) |
Decision rule: Every lessee lease that does not qualify for the short-term or low-value exemption produces a right-of-use asset under IFRS 16. The off-balance-sheet operating lease treatment under IAS 17 no longer exists for lessees.
What is IFRS 16 Right-of-Use Asset vs Operating Lease (Old IAS 17)?
Consider a transport company with fifty vehicle leases and eight warehouse leases. Under IAS 17, the auditor verified lease classification (operating vs finance) and confirmed that operating lease rentals flowed through the P&L as a flat charge. The balance sheet showed nothing. Under IFRS 16, those same leases produce right-of-use assets and lease liabilities that can add tens of millions to total assets and total debt overnight.
The practical bite comes at covenant level. IFRS 16.47 requires either separate presentation of right-of-use assets or disclosure within property, plant, and equipment. If the entity's banking facilities define "net debt" without excluding lease liabilities, IFRS 16 adoption mechanically breaches covenants that IAS 17 never triggered. ISA 570.16 requires the auditor to evaluate events or conditions that cast doubt on going concern. A covenant breach driven entirely by an accounting change (not deteriorating performance) still triggers the going-concern assessment, and the auditor must document why the entity remains a going concern despite the technical breach.
Worked example: Henriksen Shipping A/S
Client: Danish maritime logistics company, FY2025, revenue EUR 140M, IFRS reporter. Henriksen leases twelve container vessels under time-charter agreements. Each charter runs five years at an annual payment of EUR 1.8M per vessel, payable quarterly in arrears. No purchase options exist. Henriksen's incremental borrowing rate is 4.5%.
Under IAS 17 (pre-2019 treatment for reference)
The time charters qualified as operating leases because the shipowner retained the risks and rewards of ownership. Henriksen recognised a straight-line expense of EUR 1.8M per vessel per year (EUR 21.6M for the fleet). No asset or liability appeared on the balance sheet.
Documentation note: under the old model, the file recorded the lease classification, confirmed the straight-line expense, and disclosed total future minimum lease payments in the notes per IAS 17.35.
Step 1 — Measure the lease liability per vessel
The present value of twenty quarterly payments of EUR 450,000, discounted at a quarterly rate derived from 4.5% annual, is EUR 8,142,600 per vessel. For twelve vessels the total lease liability at commencement is EUR 97,711,200.
Documentation note: record the discount rate (4.5% annual, 1.1058% quarterly equivalent), the payment schedule, and the present value calculation per IFRS 16.26. Cross-reference the rate to Henriksen's most recent secured shipping facility.
Step 2 — Recognise the right-of-use asset per vessel
No prepayments, no initial direct costs, no restoration obligations. The right-of-use asset equals the lease liability: EUR 8,142,600 per vessel, EUR 97,711,200 for the fleet.
Documentation note: record the initial measurement build-up under IFRS 16.24(a)-(d), confirming that only the lease liability component applies.
Step 3 — Calculate Year 1 expense under IFRS 16
Depreciation per vessel is EUR 8,142,600 divided by five years, giving EUR 1,628,520. Interest expense in Year 1 (on the opening liability) is approximately EUR 4,397,000 for the fleet. Total Year 1 charge across twelve vessels: depreciation of EUR 19,542,240 plus interest of EUR 4,397,000, totalling EUR 23,939,240.
Documentation note: reconcile the Year 1 combined charge (EUR 23,939,240) to the IAS 17 equivalent (EUR 21,600,000). The difference of EUR 2,339,240 represents front-loading, not additional cost. Document this in the lease transition reconciliation.
Step 4 — Assess the covenant impact
Henriksen's revolving credit facility defines net debt as interest-bearing liabilities minus cash. Before IFRS 16, net debt was EUR 45M. After recognising EUR 97.7M of lease liabilities, net debt jumps to EUR 142.7M. The facility's maximum net-debt-to-EBITDA ratio of 3.5x is breached on a reported basis, even though EBITDA itself improves (lease payments of EUR 21.6M no longer reduce EBITDA).
Documentation note: record the covenant calculation before and after IFRS 16, the bank's confirmed waiver or amendment (if obtained), and the going-concern assessment per ISA 570.16.
Conclusion: the same fleet, the same cash flows, the same commercial reality. IFRS 16 adds EUR 97.7M to both sides of the balance sheet and front-loads EUR 2.3M of additional P&L expense in Year 1 relative to IAS 17. If the auditor had failed to test the covenant calculation under the new model, the going-concern disclosure could have been incomplete.
Why it matters in practice
- Teams carry forward pre-2019 working papers that classify leases as "operating" on the lessee side without recognising that IFRS 16 eliminated that category for lessees. The term "operating lease" persists in everyday language, but applying the old off-balance-sheet treatment after transition violates IFRS 16.22. ISA 500.9 requires the auditor to evaluate whether the evidence supports the accounting treatment applied, not the treatment that applied under the prior standard.
- Firms frequently omit a covenant impact analysis when lease liabilities are material. IAS 1.135(d) requires disclosure of breaches of loan-agreement terms, and ISA 570.16 requires evaluation of covenant compliance as part of the going-concern assessment. A lease portfolio that adds EUR 50M or more to reported debt changes the covenant arithmetic even when business performance is stable.
Related terms
Frequently asked questions
Do lessees still have operating leases under IFRS 16?
No. IFRS 16 removed the lessee classification test entirely. Every lease that does not qualify for the short-term exemption (IFRS 16.5(a), term of 12 months or less) or the low-value exemption (IFRS 16.5(b), underlying asset below approximately EUR 5,000) produces a right-of-use asset and a corresponding lease liability. The operating-vs-finance distinction survives only for lessors under IFRS 16.61.
How does IFRS 16 affect EBITDA compared to IAS 17?
Under IAS 17, operating lease payments reduced EBITDA because they sat in operating expenses. Under IFRS 16, those payments are replaced by depreciation of the right-of-use asset (below the EBITDA line) and interest expense on the lease liability (also below EBITDA). The result is a mechanical increase in reported EBITDA for lease-heavy entities, even though cash outflows have not changed. Analysts and lenders often adjust for this by adding back the lease liability or reverting to a pre-IFRS-16 basis.
Does the transition from IAS 17 to IFRS 16 require a restatement of prior years?
Not necessarily. IFRS 16.C5(b) permits the modified retrospective approach, which adjusts opening retained earnings at the transition date without restating comparatives. Under this method the entity measures each right-of-use asset at an amount equal to the lease liability (adjusted for any prepayments) at 1 January 2019. The full retrospective approach under IFRS 16.C5(a) restates comparatives as if IFRS 16 had always applied, but most entities chose the modified approach to avoid the cost of recalculation.