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 (or useful life if ownership transfers)
- 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 five key stages:
- Initial recognition - at the lease commencement date
- Subsequent measurement - periodic entries throughout the lease term
- Modifications - when lease terms change contractually
- Remeasurements - when estimates or circumstances change
- 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
- Lease liability at commencement: £500,000 (present value of future payments)
- ROU asset at commencement: £500,000 (no adjustments in the basic example)
For how the lease liability is calculated, see our Lease Liability guide.
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: £500,000 + £15,000 + £30,000 − £25,000 + £20,000 = £540,000. The net cash outflow of £20,000 reflects £30,000 prepaid rent plus £15,000 in direct costs, offset by the £25,000 fit-out contribution received from the landlord.
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.
Interest is highest in Year 1 (when the liability balance is largest) and declines each year as payments reduce the balance. This is what creates the "front-loaded" expense pattern under IFRS 16.
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 | 500,000 | 32,011 | (120,000) | 412,011 |
| 2 | 412,011 | 26,378 | (120,000) | 318,389 |
| 3 | 318,389 | 20,384 | (120,000) | 218,773 |
| 4 | 218,773 | 14,006 | (120,000) | 112,779 |
| 5 | 112,779 | 7,221 | (120,000) | 0 |
| Total | 100,000 | (600,000) |
Each payment covers both the interest that accrued and a principal reduction. Total interest of £100,000 plus the initial liability of £500,000 equals total payments of £600,000.
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: £500,000 ÷ 5 years = £100,000 per year
ROU Asset Movement Summary
| Year | Cost | Acc. Depreciation | Net Book Value |
|---|---|---|---|
| Commencement | 500,000 | - | 500,000 |
| End of Year 1 | 500,000 | (100,000) | 400,000 |
| End of Year 2 | 500,000 | (200,000) | 300,000 |
| End of Year 3 | 500,000 | (300,000) | 200,000 |
| End of Year 4 | 500,000 | (400,000) | 100,000 |
| End of Year 5 | 500,000 | (500,000) | 0 |
Complete Annual Entry
Bringing it all together, here are all three journals for Year 1:
P&L Impact
Total Year 1 expense: £32,011 (interest) + £100,000 (depreciation) = £132,011. This exceeds the £120,000 cash payment because interest is front-loaded under the effective interest method. By Year 5, total expense drops to £107,221 as the interest component declines.
Lease Termination (Derecognition)
At the end of the lease term, the lease liability will already be zero (unwound through prior interest and payment entries). The ROU asset will also be fully depreciated, but because depreciation is recorded through accumulated depreciation (not directly reducing the asset), a final ledger clearing entry is needed.
This entry has no P&L impact - it simply removes the asset cost and accumulated depreciation from the balance sheet.
Modification & Remeasurement 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) is £350,000, compared to the carrying amount of £318,389.
The journal entry for a remeasurement (e.g. an index-linked payment increase) follows the same pattern. If the liability increases: Dr ROU Asset, Cr Lease Liability. If it decreases: Dr Lease Liability, Cr ROU Asset. The key distinction between modifications and remeasurements is the trigger and which discount rate to use. Modifications use a revised rate; index-linked remeasurements use the original rate.
The ROU asset is adjusted to match the liability change, and revised depreciation is calculated based on the new carrying amount and remaining term. If the adjustment would reduce the ROU asset below zero, the excess is recognised in profit or loss. For scope decreases (partial terminations), the accounting is different: the ROU asset is reduced proportionately, and any difference between the asset reduction and the liability reduction is recognised as a gain or loss.
For detailed guidance, see our Modifications & Terminations guide and 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.