A contract is a lease when it gives the lessee the right to control the use of an identified asset for a period of time in exchange for consideration. The general rule of EAS 49 / IFRS 16: all leases enter the lessee's balance sheet (right-of-use asset + lease liability). The two exemptions that keep the entry a simple rent expense: short-term leases (12 months or less with no purchase option) and low-value assets (like computers and small furniture items).
The company rented an extra office for 9 months at a monthly rent of 8,000 paid from the bank — it elected the short-term exemption:
| Account | Debit | Credit |
|---|---|---|
| Rent Expense | 8,000 | |
| Bank | 8,000 |
(The entry repeats monthly — no right-of-use asset and no lease liability)
The exemption is an election the entity discloses and applies consistently — not an obligation. And a 12-month lease with a purchase option does not qualify as short-term.
At commencement: lease liability = the present value of the remaining lease payments, discounted at the rate implicit in the lease if readily determinable, otherwise at the lessee's incremental borrowing rate, and the right-of-use asset = the lease liability + initial direct costs (+ payments made before commencement − incentives received).
The company leased equipment for 3 years at an annual payment of 100,000 due at the end of each year, a discount rate of 10%, and initial direct costs (commissions and transport) of 15,315 paid in cash.
| Year-1 payment: 100,000 ÷ 1.10 | 90,909 |
| Year-2 payment: 100,000 ÷ 1.10² | 82,645 |
| Year-3 payment: 100,000 ÷ 1.10³ | 75,131 |
| Lease liability (present value) | 248,685 |
| + Initial direct costs | 15,315 |
| Right-of-use asset | 264,000 |
| Account | Debit | Credit |
|---|---|---|
| Right-of-Use Asset (equipment) | 264,000 | |
| Lease Liability | 248,685 | |
| Cash (initial direct costs) | 15,315 | |
| Total | 264,000 | 264,000 |
The liability is measured at the present value, not the sum of the payments (300,000 here) — the difference (51,315) is the interest that will be charged as a finance expense over the lease term.
After commencement, "rent expense" disappears from the income statement and is replaced by two items: interest on the liability balance (at the discount rate) and depreciation of the right-of-use asset — straight-line over the shorter of the lease term and the asset's useful life, and over the useful life when ownership transfers at the end or a purchase option is reasonably certain. Each payment settles the interest first and the remainder reduces the liability principal.
| Year 1: opening 248,685 + 10% interest (24,869) − payment 100,000 | 173,554 |
| Year 2: opening 173,554 + 10% interest (17,355) − payment 100,000 | 90,909 |
| Year 3: opening 90,909 + 10% interest (9,091) − payment 100,000 | 0 |
| Total interest over the lease term | 51,315 |
| Account | Debit | Credit |
|---|---|---|
| Interest Expense (finance cost) | 24,869 | |
| Lease Liability (principal portion) | 75,131 | |
| Bank | 100,000 | |
| Total | 100,000 | 100,000 |
| Account | Debit | Credit |
|---|---|---|
| ROU Depreciation Expense (264,000 ÷ 3) | 88,000 | |
| Accumulated Depreciation — ROU Asset | 88,000 |
Year-1 income-statement expense = interest 24,869 + depreciation 88,000 = 112,869 (more than the 100,000 payment) — the usual IFRS 16 pattern: expense is front-loaded, lower in later years, and the total over the term is the same.
Killing the finance/operating distinction applied to lessees only. A lessor still classifies: a finance lease (substantially transferring the risks and rewards of ownership) → derecognize the asset, recognize a lease receivable (net investment), and split receipts between interest (finance income) and principal; an operating lease → keep the asset on the books and depreciate it, with rent as straight-line income.
The company rented out its own equipment under an operating lease at a monthly rent of 12,000 collected by bank:
| Account | Debit | Credit |
|---|---|---|
| Bank | 12,000 | |
| Rental Income | 12,000 |
(And the lessor keeps depreciating the equipment as its own fixed asset, as usual)
A finance lessor collected an annual installment of 100,000, of which 24,869 is interest and the rest reduces the receivable:
| Account | Debit | Credit |
|---|---|---|
| Bank | 100,000 | |
| Finance Income (lease interest) | 24,869 | |
| Finance Lease Receivables | 75,131 | |
| Total | 100,000 | 100,000 |
Not every contract called a "lease" or "service" enters the balance sheet. No right-of-use asset is recorded in these cases:
1) A service contract with no identified asset: a cloud subscription, a goods-transport contract with no specific truck dedicated, security and cleaning services — expense as received, no asset, no liability.
2) The supplier has a substantive right to substitute the asset at will and benefits from doing so: there is no "identified asset" → a service contract.
3) Short-term leases and low-value assets (by election): straight-line rent expense (Topic 1.1).
4) Signing the contract before the availability date: no entry until the asset is made available for use to the lessee.
5) Variable performance-linked rents (e.g., a percentage of sales): excluded from measuring the liability — expensed in the period incurred.
Ask two questions: is there an identified asset? and do we control its use? If either is missing, it is a service contract charged to expense — no right-of-use, no liability.