Common IFRS 16 Mistakes and How to Fix Them

The Error

Many companies use a single IBR for all leases, or apply their weighted average cost of capital (WACC) without proper adjustment. Some use the parent company's borrowing rate for all subsidiaries regardless of jurisdiction.

Impact: Can misstate lease liabilities by 5-15%, affecting debt covenants and financial ratios.

How to Fix It

1. Determine entity-specific rate: Use the rate the lessee would pay to borrow funds to obtain an asset of similar value
2. Adjust for lease term: A 3-year lease requires a different rate than a 10-year lease
3. Consider currency: USD leases need USD-denominated rates, not local currency rates
4. Factor in security: Secured vs. unsecured borrowing rates differ
5. Update regularly: Review rates at least annually and for each new lease

Prevention Tips

• Document IBR determination methodology in accounting policies
• Maintain a rate matrix by currency, term, and entity
• Consult treasury team or external advisors for complex situations
• Use our IBR Selection Guide for detailed methodology

The Error

Including all variable payments (performance-based, usage-based, revenue-share) in the initial lease liability measurement, rather than only index/rate-based payments.

Impact: Overstates lease liability and ROU asset, distorts debt ratios and asset turnover metrics.

How to Fix It

1. Review contracts: Identify all variable payment clauses
2. Categorize payments:
   • Include in liability: Payments based on index (CPI) or rate (LIBOR)
   • Exclude from liability: Performance-based, usage-based, revenue-share payments
3. Use initial values: For index/rate payments, use the index/rate at commencement date
4. Remeasure only when triggered: Update liability only when index/rate changes AND payment amounts are adjusted
5. Expense variable portions: Recognize excluded variable payments in P&L when incurred

Prevention Tips

• Create a checklist to categorize each payment type in new leases
• Maintain a variable payment register to track remeasurement triggers
• See our detailed guide: Variable Lease Payments Under IFRS 16

The Error

Treating all lease changes as modifications and remeasuring, or conversely, failing to account for modifications at all. Not distinguishing between separate new leases and modifications to existing leases.

Impact: Incorrect ROU asset and liability balances, misstated depreciation and interest expense.

How to Fix It

1. Identify the change type:
   • Separate lease: Adds right to use additional underlying assets + consideration commensurate with standalone price
   • Modification (increase): Adds rights but consideration not commensurate
   • Modification (decrease): Reduces scope (e.g., space reduction)
2. Apply correct treatment:
   • Separate lease: Account as new lease alongside existing lease (no remeasurement)
   • Modification (increase): Remeasure liability, increase ROU asset by difference
   • Modification (decrease): Remeasure liability, reduce ROU asset proportionately, recognize gain/loss
3. Update discount rate: Use revised IBR at modification date for remeasurement
4. Recalculate schedules: Generate new amortization schedules from modification date

Prevention Tips

• Develop modification decision tree for consistency
• Obtain market rate evidence for separate lease assessment
• See detailed examples: Lease Modification Examples

The Error

Using only the non-cancellable period, ignoring renewal options that are "reasonably certain" to be exercised, or conversely, including all optional periods regardless of likelihood.

Impact: Understates or overstates lease liability, affecting debt covenants and comparability.

How to Fix It

1. Start with non-cancellable period: Minimum lease term
2. Assess extension options: Consider:
   • Economic incentives (favorable terms, leasehold improvements)
   • Business strategy (long-term operational need)
   • Costs to terminate (penalties, relocation costs)
   • Asset specificity (custom-built facilities)
3. Assess termination options: Reasonably certain NOT to exercise?
4. Document judgment: Support lease term conclusion with evidence
5. Reassess when facts change: Modification, significant event, lessee-controlled trigger

Prevention Tips

• Develop lease term assessment framework with decision criteria
• Involve operations teams who understand business intent
• Review lease term assumptions annually for significant leases

The Error

Including service charges (maintenance, utilities, common area costs) in lease liability when they should be accounted for as separate service contracts under IFRS 15.

Impact: Overstates ROU asset and lease liability, inflates depreciation expense.

How to Fix It

1. Identify components:
   • Lease components: Right to use underlying asset (space, equipment)
   • Non-lease components: Services (maintenance, security, utilities)
2. Allocate consideration: Based on relative standalone prices (or observable standalone prices)
3. Account separately:
   • Lease component → IFRS 16 (ROU asset + liability)
   • Non-lease component → IFRS 15 (expense as incurred or prepaid)
4. Practical expedient option: Can elect NOT to separate for entire class of assets (e.g., all real estate)

Prevention Tips

• Obtain detailed invoices showing component breakdowns
• Consider practical expedient election for simplicity (if policy is appropriate)
• Apply consistently across asset classes

#6: Misapplying Practical Expedients Post-Transition

Error: Attempting to use transition-specific practical expedients (e.g., not reassessing lease identification) for new leases entered after transition date.

Fix: Understand that most practical expedients apply ONLY at transition. Only short-term lease and low-value asset exemptions continue ongoing.

Prevention: Maintain separate policies for transition vs. ongoing accounting.

#7: Incorrect Initial Direct Cost Capitalization

Error: Capitalizing internal costs, general overhead, or costs that would be incurred regardless of lease execution (e.g., legal review of multiple potential properties).

Fix: Only capitalize incremental costs directly attributable to obtaining the specific lease (broker commissions, payments to existing tenant to vacate).

Prevention: Create approved list of capitalizable costs with examples.

#8: Ignoring Deferred Tax Implications

Error: Not recognizing deferred tax assets/liabilities on ROU assets and lease liabilities, especially after January 2023 IAS 12 amendments.

Fix: Calculate temporary differences between carrying amounts and tax bases, recognize DTA and DTL at applicable tax rate.

Prevention: Integrate lease data with tax reporting systems. See our guide: Deferred Tax Implications of IFRS 16

#9: Poor Lease Data Management

Error: Decentralized lease records, missing critical information (commencement dates, payment schedules), no systematic tracking of modification triggers.

Fix: Implement centralized lease repository with complete data (contracts, amendments, payment evidence, key dates).

Prevention: Establish lease intake process, assign lease owner responsibilities, conduct quarterly data quality reviews.

#10: Inadequate Disclosure

Error: Providing boilerplate disclosures without entity-specific judgments, maturity analysis errors, missing weighted average information.

Fix: Ensure disclosures include:

• Significant judgments (lease term, IBR, variable payments)
• Maturity analysis of lease liabilities
• Weighted average remaining lease term and discount rate
• Expense for short-term/low-value leases
• Commitments for leases not yet commenced

Prevention: Use disclosure checklist, review exemplar disclosures from peers.