IFRS 16 Leases Explained: Right-of-Use Assets, Lease Liabilities and a Worked Example
How IFRS 16 (NFRS 16 in Nepal) works for lessees: the lease liability, the right-of-use asset, interest, depreciation and journal entries, with an example.
“Off-balance-sheet? Not anymore.” — Every auditor since 2019
Your office rent used to be a single line in the profit and loss account. Since IFRS 16 (in Nepal, NFRS 16), almost every lease shows up on the balance sheet as an asset and a liability, and the rent expense splits into interest and depreciation.
This post explains how a lessee measures a lease, what happens each year, and a full five-year example with the schedule and journal entries.
🏢 What IFRS 16 Changed
Under the old standard, IAS 17, an operating lease such as office rent stayed off the balance sheet: you just expensed the rent. IFRS 16, effective for periods beginning on or after 1 January 2019, uses one model for lessees. For nearly every lease you recognise:
- a right-of-use (ROU) asset: your right to use the office, vehicle or equipment for the lease term
- a lease liability: your obligation to pay for it
In Nepal the equivalent standard is NFRS 16 Leases, effective from 16 July 2021.
Two exemptions are optional. You can keep expensing short-term leases (12 months or less) and leases of low-value assets straight-line, as before.
📐 Measuring the Lease at the Start
Lease liability = the present value of the lease payments not yet paid, discounted at the rate implicit in the lease. If that rate can’t be readily determined, which is usually the case for a lessee, you use your incremental borrowing rate (IBR): what you’d pay to borrow a similar amount, for a similar term, against similar security.
Right-of-use asset = the lease liability
- plus any lease payments made at or before the start
- plus initial direct costs, such as a broker’s commission for arranging the lease
- plus the estimated cost of restoring the premises at the end, if you have to
- less any lease incentives received from the landlord
graph TD
A[Lease payments over the term] --> B[Discount at the incremental borrowing rate]
B --> C[Lease liability]
C --> D[Add prepayments, initial direct costs and restoration; less incentives]
D --> E[Right-of-use asset]
C --> F[Each period: add interest, deduct the payment]
E --> G[Each period: depreciate straight-line]
🔁 After the Start: Interest and Depreciation
- The liability grows by interest (opening balance × rate) and falls by each payment, like a loan.
- The ROU asset is depreciated, usually straight-line, over the lease term, or over the asset’s useful life if that’s shorter.
- Profit and loss shows interest expense and depreciation instead of rent. Interest is highest at the start, so the total expense is front-loaded: higher than the rent in early years and lower later. Over the whole lease, the total expense equals what the lease cost you: the payments plus any initial direct costs.
- Cash flow statement: the principal part of each payment goes under financing activities.
🧮 A Worked Example
Your company leases an office from Shrawan 1, 2083 (17 July 2026) for 5 years:
- Rent of Rs. 12,00,000 for the first year, paid at the end of each year
- Rent rises 5% a year: Rs. 12,60,000, 13,23,000, 13,89,150 and 14,58,607.50
- Incremental borrowing rate: 10% a year
- You paid a broker Rs. 50,000 to arrange the lease (an initial direct cost)
Starting the lease on Shrawan 1 makes each lease year line up with Nepal’s fiscal year.
At the start
| Rs. | |
|---|---|
| Total rent over 5 years (undiscounted) | 66,30,757.50 |
| Lease liability (present value at 10%) | 49,80,709.53 |
| Plus initial direct costs | 50,000.00 |
| Right-of-use asset | 50,30,709.53 |
Journal entry on 17 July 2026:
| Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|
| Right-of-use asset | 50,30,709.53 | |
| Lease liability | 49,80,709.53 | |
| Cash (broker’s commission) | 50,000.00 |
On the balance sheet, Rs. 7,01,929.05 of the liability is current, because that much principal is repaid within 12 months. The other Rs. 42,78,780.48 is non-current.
The lease schedule
| Year | Opening liability | Interest (10%) | Payment | Closing liability | Depreciation | ROU asset (net) |
|---|---|---|---|---|---|---|
| 1 | 49,80,709.53 | 4,98,070.95 | 12,00,000.00 | 42,78,780.48 | 10,06,141.90 | 40,24,567.63 |
| 2 | 42,78,780.48 | 4,27,878.05 | 12,60,000.00 | 34,46,658.53 | 10,06,141.90 | 30,18,425.73 |
| 3 | 34,46,658.53 | 3,44,665.85 | 13,23,000.00 | 24,68,324.38 | 10,06,141.90 | 20,12,283.83 |
| 4 | 24,68,324.38 | 2,46,832.44 | 13,89,150.00 | 13,26,006.82 | 10,06,141.90 | 10,06,141.93 |
| 5 | 13,26,006.82 | 1,32,600.68 | 14,58,607.50 | 0.00 | 10,06,141.93 | 0.00 |
| Total | 16,50,047.97 | 66,30,757.50 | 50,30,709.53 |
Journal entries at the end of year 1
| Account | Debit (Rs.) | Credit (Rs.) |
|---|---|---|
| Interest expense | 4,98,070.95 | |
| Lease liability | 4,98,070.95 | |
| Lease liability | 12,00,000.00 | |
| Cash | 12,00,000.00 | |
| Depreciation expense | 10,06,141.90 | |
| Accumulated depreciation, ROU asset | 10,06,141.90 |
What it does to profit
In year 1 you expense Rs. 15,04,212.85 (interest plus depreciation), although you paid only Rs. 12,00,000 in rent. In year 5 it’s the other way round: Rs. 11,38,742.61 of expense against Rs. 14,58,607.50 paid. Over the five years the expense adds up to Rs. 66,80,757.50, which is exactly the rent plus the broker’s commission.
Maturity analysis
IFRS 16 also asks for a maturity analysis of the lease liability: the undiscounted payments by when they fall due.
| Due | Rs. |
|---|---|
| Within 1 year | 12,00,000.00 |
| 1 to 2 years | 12,60,000.00 |
| 2 to 3 years | 13,23,000.00 |
| 3 to 4 years | 13,89,150.00 |
| 4 to 5 years | 14,58,607.50 |
| Total undiscounted payments | 66,30,757.50 |
| Less: interest still to be recognised | (16,50,047.97) |
| Lease liability | 49,80,709.53 |
Try it: IFRS 16 Lease Schedule — put in your own lease terms (monthly, quarterly or annual payments, in advance or arrears, with a yearly increase) to get the full schedule, journal entries and maturity analysis, with CSV export.
⚠️ What This Doesn’t Cover
This post covers a lessee with fixed payments. It leaves out variable payments, residual value guarantees, purchase, extension and termination options, lease modifications and remeasurement, sale-and-leaseback, and lessor accounting. A restoration cost also needs its own provision under IAS 37. Treat this as a learning aid, not accounting advice, and check the full standard for your own leases.
📚 Sources
- IFRS 16 Leases (IFRS Foundation)
- Nepal Financial Reporting Standards 2018, including NFRS 16 Leases (Accounting Standards Board Nepal)
Rent isn’t just an expense anymore. It’s an asset, a liability, and a schedule. 📊