Strategic Business Reporting (International) · Leases

IFRS 16 Lease Presentation, Disclosure and Reporting Issues

Updated 11 October 2026 · Fact-checked

Under IFRS 16 a lessee shows right-of-use assets and lease liabilities on the statement of financial position, depreciation and interest in profit or loss, and principal repayments in financing cash flows. This raises assets, debt and EBITDA, and lowers interest cover. You must explain these effects and any ethical pressure around them.

Understand Lease Presentation, Disclosure and Ethical/Reporting Issues

Before IFRS 16, many leases were operating leases. Rent was an expense and nothing sat on the statement of financial position. IFRS 16 removed this for lessees. Almost every lease now creates a right-of-use asset and a lease liability.

Presentation follows from that. The asset is shown either as a separate line or within the line where owned assets of the same kind would appear, with disclosure of which lines include them. The liability is split into current and non-current. In profit or loss, the single rent expense is replaced by depreciation of the asset and interest on the liability. Interest is a finance cost and must not be buried in operating costs.

In the cash flow statement, cash paid for the principal portion of the liability goes in financing activities. Interest paid goes in operating or financing, following the entity's policy for interest under IAS 7. Payments for short-term leases, low-value leases and variable payments not in the liability can go in operating activities.

Disclosure aims to let users assess the effect of leases. Key items are: depreciation charge by class of asset, interest expense on lease liabilities, expense for short-term leases, low-value leases and variable payments not in the liability, total cash outflow for leases, additions to right-of-use assets, and a maturity analysis of lease liabilities (under IFRS 7). Narrative on the nature of leases, extension and termination options and restrictions is also needed.

The analysis side is where SBR examiners push. Assets and debt go up. EBITDA goes up because the whole expense moves below that line. Operating profit rises because only the interest part moves out of operating costs. Profit before tax is lower in early years because interest is front-loaded. Gearing rises, interest cover falls, return on capital employed usually falls and asset turnover falls. Total cash flow does not change. Only its classification changes. Covenants based on debt or EBITDA may be affected, which creates pressure to renegotiate terms or to structure leases to stay off the statement of financial position.

Key rules to remember

Lease expense replaced: Old rent expense → depreciation of ROU asset + interest on lease liability; Total expense over the lease is similar, but it is front-loaded under IFRS 16.
Interest on lease liability: Opening liability × discount rate; Presented as a finance cost.
Cash flow classification: Principal repaid → financing; interest → operating or financing per policy; Short-term, low-value and variable payments not in the liability are normally operating.
EBITDA effect: EBITDA = operating profit + depreciation + amortisation; Lease depreciation is added back, so EBITDA rises by the former rent on capitalised leases.
Gearing: Debt ÷ equity, or debt ÷ (debt + equity); State whether lease liabilities are included. Including them raises gearing.
Interest cover: Profit before interest and tax ÷ finance costs; Falls as lease interest is added to finance costs.

How to solve Lease Presentation, Disclosure and Ethical/Reporting Issues questions

Use this method for any discussion or calculation question on lease presentation, disclosure or effects.

1Identify the lessee's leases and note any exemptions: short-term, low-value, and variable payments.
2Work out the statement of financial position entries: ROU asset, and current and non-current lease liability.
3Work out profit or loss: depreciation plus interest, replacing rent.
4Place cash flows: principal in financing, interest per policy, exempt payments in operating.
5List the disclosures the scenario needs, such as maturity analysis, depreciation by class and total cash outflow.
6Show the effect on each named ratio or measure with direction and reason, using numbers if given.
7Add the wider issues: covenants, management bonuses, comparability, and any pressure to avoid capitalisation.
8Conclude with a view on the user's interpretation, and the ethical response if integrity is threatened.

Quickest way: Direction and reason table

When to use it: Use this for short discussion requirements worth a few marks, where you must explain the effect on ratios.

Write the three moves: assets up, debt up, rent becomes depreciation plus interest.
State each measure's direction: EBITDA up, operating profit up, profit before tax down early on, gearing up, interest cover down.
Add one sentence that cash is unchanged, only classified differently.
Link to the scenario: covenants, bonuses or comparison with a non-IFRS 16 competitor.
Finish with the action: adjust ratios or renegotiate covenant definitions.

Common mistakes in Lease Presentation, Disclosure and Ethical/Reporting Issues

Saying IFRS 16 improves cash flow
Operating cash flow rises, which looks like an improvement.
Fix: Say only the classification changes. Principal moves to financing. Total cash is the same.
Claiming profit rises in every year
EBITDA and operating profit go up, so students assume profit does too.
Fix: Interest is front-loaded, so profit before tax is lower early in the lease and higher later.
Putting lease interest in operating costs
Students keep treating it as rent.
Fix: Show it as a finance cost, separate from depreciation.
Forgetting exemptions in disclosure and cash flows
Students apply capitalisation to everything.
Fix: Remember short-term and low-value leases can be expensed, with the expense disclosed.
Ignoring covenants and bonuses
Answers stay on the technical rules.
Fix: Link the changes to loan covenants, remuneration targets and the incentive to manage reported figures.
Comparing with a rival without checking its standard
Students assume all entities report alike.
Fix: Note that some entities may report under other frameworks with different lease treatment, so adjust before comparing.

Worked examples

Example 1

Zeta has operating profit of $8m after a rent expense of $2m on a lease it has not yet capitalised. Under IFRS 16 the lease would give depreciation of $1.6m and interest of $0.5m. Depreciation and amortisation otherwise total $3m. Calculate operating profit and EBITDA before and after IFRS 16 and explain the effect.

Show the solution

Before: operating profit is $8m. EBITDA = 8 + 3 = $11m.
After: the rent of $2m is removed. Depreciation of $1.6m is charged in operating costs. Interest of $0.5m is below operating profit.
Operating profit = 8 + 2 − 1.6 = $8.4m.
EBITDA = 8.4 + 3 + 1.6 = $13m.
Profit before tax change: before it is 8 less other finance costs. After it is 8.4 − 0.5 = 7.9 less the same other costs. So profit is $0.1m lower.
Explain: operating profit and EBITDA rise because the rent leaves operating costs. EBITDA rises by the full $2m. Profit falls slightly because the combined charge of $2.1m exceeds the rent of $2m.

Answer: Operating profit rises from $8m to $8.4m. EBITDA rises from $11m to $13m. Profit before tax falls by $0.1m.

Example 2

Karta Co is considering lease liabilities of $12m, and its existing debt is $20m with equity of $40m. A loan covenant limits debt ÷ equity to 0.60. Discuss the effect of IFRS 16 on the covenant and the ethical issues that arise. Assume equity is unchanged.

Show the solution

Before: gearing = 20 ÷ 40 = 0.50, within the covenant.
After including leases: debt = 20 + 12 = $32m. Gearing = 32 ÷ 40 = 0.80.
This breaches the 0.60 limit if the covenant definition of debt includes lease liabilities.
Check the loan agreement. Many covenants are defined by frozen GAAP or specific definitions, so the breach may not apply. Otherwise the lender may need to be approached.
Ethical issue: management may be tempted to avoid capitalising leases, for example by splitting contracts, misjudging lease term or claiming no identified asset.
This would breach integrity and objectivity, and the accountant should challenge it and escalate if needed.
Recommend: apply IFRS 16 correctly, disclose clearly, and negotiate the covenant definition with the lender before the reporting date.

Answer: Gearing moves from 0.50 to 0.80, breaching the covenant if lease liabilities count as debt. The correct response is to apply IFRS 16 properly and renegotiate the covenant, not to manipulate the accounting.

Exam tips

Always give direction and reason for each ratio. A bare statement that gearing rises earns little.
Say cash is unchanged. Examiners reward this point.
Use the scenario figures. Calculate the before and after where numbers are given.
Link to ethics when the scenario hints at covenants, bonuses or pressure on the preparer, and show professional scepticism.
Lay out disclosure answers as a short list of items, tied to the entity's actual leases.

Practice questions from Leases

Lease Presentation, Disclosure and Ethical/Reporting Issues in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Lease Presentation, Disclosure and Ethical/Reporting Issues: frequently asked questions

Where do lease payments go in the cash flow statement under IFRS 16?

The principal part goes in financing activities. Interest goes in operating or financing, depending on the entity's policy under IAS 7. Payments on short-term, low-value and variable leases outside the liability are usually operating.

Why does EBITDA go up under IFRS 16?

Rent is no longer an operating expense for capitalised leases. It is replaced by depreciation and interest, both of which sit below EBITDA. EBITDA therefore rises by the amount of the former rent.

Does IFRS 16 change the total expense over a lease?

Over the whole lease the total charge is broadly similar. The timing changes because interest is higher early on, so the profit or loss charge is front-loaded.

What must a lessee disclose about leases?

It must give depreciation by class of ROU asset, interest on lease liabilities, expenses for short-term, low-value and variable leases, total cash outflow, additions to ROU assets and a maturity analysis. It should also add narrative on the nature of its leases and options.