Key Takeaways
- Initial recognition requires debit to ROU asset and credit to lease liability (plus any adjustments)
- Periodic journals include interest expense, depreciation, and lease payments
- Interest expense is calculated using the effective interest method (opening liability × discount rate)
- Depreciation is typically straight-line over the lease term
- At lease end, derecognition journals remove the asset and accumulated depreciation from the balance sheet
Overview of IFRS 16 Journal Entries
IFRS 16 lease accounting for lessees involves journal entries at three key stages:
- Initial recognition - at the lease commencement date
- Subsequent measurement - periodic entries throughout the lease term
- Derecognition - at the end of the lease or upon early termination
This guide provides worked examples for each stage, using consistent figures to show how the entries flow through the lease lifecycle.
Running Example
Throughout this guide, we use a 5-year property lease with:
- Annual rent: £120,000 with 5% annual escalations
- Lease liability at commencement: £555,456
- ROU asset at commencement: £555,456
- Discount rate: 6%
Initial Recognition
At the lease commencement date, the lessee recognises both the lease liability and the right-of-use asset.
Basic Initial Recognition
In the simplest case, where the ROU asset equals the lease liability:
Initial Recognition with Adjustments
In practice, the ROU asset often differs from the lease liability due to:
- Initial direct costs
- Prepayments made before commencement
- Lease incentives received
- Restoration provisions
Scenario with Adjustments
Same lease, but with:
- Legal fees: £15,000
- Rent prepaid at signing: £30,000
- Fit-out contribution from landlord: £25,000
- Restoration obligation: £20,000
Total ROU asset recognised: £555,456 + £15,000 + £30,000 − £25,000 + £20,000 = £595,456
Periodic Interest Expense
The lease liability is measured using the effective interest method. Interest expense is calculated by multiplying the opening liability balance by the discount rate.
Annual Interest Entries
| Year | Opening Liability | Interest (6%) |
|---|---|---|
| 1 | £555,456 | £33,327 |
| 2 | £468,783 | £28,127 |
| 3 | £370,910 | £22,255 |
| 4 | £260,865 | £15,652 |
| 5 | £137,602 | £8,259 |
| Total | £107,620 |
Monthly vs Annual
For monthly accounting, divide the annual interest by 12 (or calculate monthly using the monthly discount rate). Most companies accrue interest monthly, so the Year 1 monthly entry would be approximately £2,777 (£33,327 ÷ 12).
Lease Payment Entries
Lease payments reduce the lease liability (and cash). They do not affect the income statement directly - the P&L impact comes from interest expense and depreciation.
Liability Movement Summary
| Year | Opening | Interest | Payment | Closing |
|---|---|---|---|---|
| 1 | 555,456 | 33,327 | (120,000) | 468,783 |
| 2 | 468,783 | 28,127 | (126,000) | 370,910 |
| 3 | 370,910 | 22,255 | (132,300) | 260,865 |
| 4 | 260,865 | 15,652 | (138,915) | 137,602 |
| 5 | 137,602 | 8,259 | (145,861) | 0 |
Depreciation Entries
The ROU asset is depreciated over the lease term (or useful life if ownership transfers). Straight-line depreciation is most common.
Using our basic example: £555,456 ÷ 5 years = £111,091 per year
ROU Asset Movement Summary
| Year | Cost | Acc. Depreciation | Net Book Value |
|---|---|---|---|
| Commencement | 555,456 | - | 555,456 |
| End of Year 1 | 555,456 | (111,091) | 444,365 |
| End of Year 2 | 555,456 | (222,182) | 333,274 |
| End of Year 3 | 555,456 | (333,273) | 222,183 |
| End of Year 4 | 555,456 | (444,364) | 111,092 |
| End of Year 5 | 555,456 | (555,456) | 0 |
Complete Monthly Entry
In practice, most companies post monthly journals. Here's a complete monthly entry for Year 1:
P&L Impact
Total monthly expense: £2,777 (interest) + £9,258 (depreciation) = £12,035
This is higher than the £10,000 cash rent because interest is front-loaded under the effective interest method. The expense profile is "accelerated" compared to the old straight-line operating lease treatment.
Lease Termination (Derecognition)
At the end of the lease term, both the lease liability and ROU asset should be fully reduced. However, because depreciation is recorded through accumulated depreciation (not directly reducing the asset), a final journal is needed to clear both accounts.
This entry has no P&L impact - it simply removes the asset cost and accumulated depreciation from the balance sheet.
Modification Entries
When a lease is modified and the modification is not accounted for as a separate lease, the lease liability and ROU asset are remeasured.
Modification Scenario
At the start of Year 3, the lessee extends the lease by 2 years. The revised lease liability (at a revised discount rate of 5%) is £400,000, compared to the carrying amount of £370,910.
The ROU asset is increased to match the liability increase. The revised depreciation expense going forward is calculated based on the revised ROU asset carrying amount and remaining lease term.
For detailed modification accounting, see our Modifications & Terminations guide.
Remeasurement Entries
When lease payments change due to index/rate changes, the lease liability is remeasured using the original discount rate.
Index-Linked Remeasurement
A CPI-linked lease is remeasured when CPI increases by 3%. The liability increase is £15,000.
For detailed remeasurement guidance, see our Remeasurement guide.
Journal Entry Summary
| Transaction | Debit | Credit |
|---|---|---|
| Initial recognition | ROU Asset | Lease Liability |
| Interest expense | Interest Expense | Lease Liability |
| Lease payment | Lease Liability | Cash |
| Depreciation | Depreciation Expense | Accumulated Depreciation |
| Modification (increase) | ROU Asset | Lease Liability |
| Modification (decrease) | Lease Liability | ROU Asset / P&L |
| Derecognition | Accumulated Depreciation | ROU Asset |
This article is provided for general informational purposes only and does not constitute accounting, legal or professional advice.