IFRS 16: Leases & Business Central Configuration - Part 1: Introduction & Core Concepts

Lease accounting changed fundamentally in 2019. With the introduction of IFRS 16, the traditional distinction between operating and finance leases - and the off-balance-sheet treatment that came with it - was effectively eliminated for lessees.

If your organisation leases buildings, vehicles, machinery, or equipment, IFRS 16 affects you. This series walks through exactly what the standard requires and how to implement it correctly in Microsoft Dynamics 365 Business Central, from initial recognition through to disclosure.

This post covers:

• Why IFRS 16 was introduced and what problem it solved

• What changed from IAS 17 (the old standard)

• FRS 102 (2024 Amendments) for UK and Ireland SMEs

• Exemptions available under IFRS 16

• Key concepts essential to understand before any Business Central configuration

• Impact of IFRS 16 on key financial KPIs

Why Was IFRS 16 Introduced?

Before IFRS 16, leases were classified as either finance leases (recognised on the balance sheet) or operating leases (maintained entirely off the balance sheet and disclosed only in the notes).

The International Accounting Standards Board (IASB) identified a fundamental problem with this approach. Analysis of listed companies revealed that approximately $3 trillion of lease obligations were being held off-balance-sheet globally, invisible to investors unless they applied their own manual adjustments to financial statements.

This was particularly acute in industries such as airlines, retail, and transport, where operating leases for aircraft, stores, and fleet represented the most significant financial commitments a business carried yet appeared nowhere on the face of the balance sheet.

IFRS 16 was issued in January 2016 and became effective for annual periods beginning on or after 1 January 2019. Its core principle is clear: almost all leases go on the balance sheet. For lessees, the distinction between operating and finance leases was effectively eliminated.

What Changed from IAS 17?

The table below summarises the key differences from a lessee perspective:

FRS 102 for SMEs in UK and Ireland

While listed UK and global companies adopted IFRS 16 from 2019, unlisted companies and SMEs in the UK and Ireland have their own deadline: compliance with the FRS 102 (2024 Amendments) is required for accounting periods beginning on or after 1 January 2026.

The 2024 amendments to FRS 102 deliberately align lease accounting for UK SMEs with the IFRS 16 model. The same Right-of-Use asset and lease liability approach now applies, regardless of whether a company reports under IFRS or UK GAAP.

For finance professionals already familiar with IFRS 16, FRS 102 (2024) will feel immediately recognisable. The FRC explicitly modelled the amendments on IFRS 16, making the underlying accounting mechanics consistent across both frameworks. The differences that remain are largely around disclosure burden and transition simplicity, not the core accounting treatment.

💡In practice: If you understand IFRS 16, you already understand the heart of FRS 102 (2024) lease accounting.

Exemptions Under IFRS 16

IFRS 16 applies when a contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. However, two practical exemptions allow lessees to avoid balance-sheet recognition and instead expense payments on a straight-line basis over the lease term.

Exemption 1 - Short-Term Leases: Leases with a term of 12 months or less at the commencement date, including any extension options. Note that if a lessee is reasonably certain to exercise an extension option, that extension period must be included in the lease term, which may take it beyond 12 months and remove the exemption.

Exemption 2 - Low-Value Assets: The IASB guidance suggests a threshold of approximately USD 5,000. This is assessed on an individual asset basis regardless of materiality to the entity as a whole. So even if a company has 500 identical low-value assets, each is assessed individually.

⚙️ Key point for BC configuration: Understanding which leases qualify for exemptions is essential before setting up any lease in Business Central, as exempt leases are expensed directly and require no ROU asset or lease liability setup.

Key Concepts to Understand Before Business Central Configuration

Before touching any Business Central setup, these four concepts must be fully understood. Getting this wrong at inception creates errors that compound throughout the lease term.

1. The Right-of-Use (ROU) Asset

The ROU asset represents the lessee's right to use the underlying asset over the lease term. Its initial cost comprises:

• The initial measurement of the lease liability

• Any lease payments made at or before the commencement date, less any lease incentives received

• Any initial direct costs incurred by the lessee

• An estimate of costs to dismantle or restore the underlying asset, where applicable

The ROU asset is depreciated over the shorter of the lease term or the useful life of the underlying asset. If ownership is expected to transfer at the end of the lease, depreciation is over the useful life of the asset rather than the lease term.

2. The Lease Liability

The lease liability is recognised at the present value of all future lease payments, discounted at the rate implicit in the lease. Where that rate cannot be readily determined - which is the case for most lessees - the incremental borrowing rate (IBR) is used instead.

Subsequent measurement involves increasing the liability for interest accrued and reducing it for cash payments made during the period.

3. The Discount Rate

Choosing the right discount rate is one of the most judgement-intensive areas of IFRS 16. Most lessees use an Incremental Borrowing Rate (IBR), defined as the rate the lessee would pay to borrow funds to obtain a similar asset over a similar term in a similar economic environment.

IBRs should be:

• Documented and supportable at commencement date

• Applied consistently across similar lease portfolios

• Reviewed when lease modifications occur

📋 Practical note: A higher IBR produces a lower lease liability and a lower ROU asset. IBR selection has a direct and material impact on the balance sheet. This is an area where auditors will scrutinise both the rate selected and the supporting evidence.

4. Lease Term

The lease term is the non-cancellable period plus:

• Any optional extension periods the lessee is reasonably certain to exercise

• Less any optional termination periods the lessee is reasonably certain to exercise

The assessment of what is "reasonably certain" requires judgement and should consider economic incentives, business plans, and historical behaviour. This determination directly affects the lease liability calculation and must be reassessed when circumstances change.

Impact on Key Financial KPIs

IFRS 16 does not change the economics of a lease - the cash flows remain the same. What changes is how those cash flows are presented and how they affect reported metrics. Finance teams, investors, and lenders need to understand these impacts before and after adoption.

⚠️  Important for covenant compliance: If your organisation has bank covenants based on leverage ratios, interest cover, or net debt, IFRS 16 adoption can trigger a technical breach even where the underlying business has not changed. Lenders should be engaged before transition - not after.

Up Next - Post 2: Measurement Under IFRS 16

How to calculate the initial lease liability step by step, determine the ROU asset value, and handle subsequent measurement including interest accrual, depreciation posting, and lease modifications - all illustrated with a worked example.