The On-Balance-Sheet Model
IFRS 16 removed the operating vs finance lease distinction for lessees. Almost every lease is now recognised on the balance sheet as a right-of-use asset with a corresponding lease liability, measured at the present value of future lease payments.
Determining the Discount Rate
The lease liability is discounted using the rate implicit in the lease, if readily determinable — which for most commercial leases, it isn't. In practice, businesses use their incremental borrowing rate: the rate the lessee would have to pay to borrow, over a similar term and with similar security, the funds necessary to obtain an asset of similar value.
Building a defensible incremental borrowing rate typically means starting from a risk-free rate for the relevant currency and term, then adding an entity-specific credit spread and adjusting for the asset being secured by the leased asset itself. This is one of the most commonly challenged estimates in an IFRS 16 audit.
What's Exempt
Two practical exemptions remain: short-term leases (12 months or less at commencement, with no purchase option) and leases of low-value assets when new (IASB guidance suggests around $5,000 or less). Both can be expensed on a straight-line basis instead of capitalised.
Remeasurement Triggers
The lease liability isn't fixed at initial recognition. Lease modifications, changes in the lease term (such as reassessing renewal options), and changes in expected payments under residual value guarantees all trigger remeasurement of the liability, with a corresponding adjustment to the right-of-use asset.
Common Judgment Areas
The lease term itself is judgmental where renewal or termination options exist — the standard requires including periods covered by an option only if the lessee is 'reasonably certain' to exercise it, which requires an economic assessment, not just a contractual reading.