May 17, 2026
Measurement under IFRS 16 - Part 2: ROU Asset, Lease Liability & Measurement at Each Reporting Period
- IFRS 16
- Leases
- Business Central
By Shailesh Apte, Chartered Accountant and Business Central Solution Architect
If Part 1 answered "what does IFRS 16 require and why?", Part 2 answers the question finance professionals actually lose sleep over: "how do I calculate it?" |
I covered the conceptual framework in Part 1: the Right-of-Use asset, the lease liability, discount rates, lease term, and the two exemptions.
Now we move from framework to figures. By the end of this post, you will be able to calculate an opening lease liability, build a complete amortisation schedule, and understand the key accounting entries. All of which are essential for how Business Central needs to be configured.
Initial Measurement: The Lease Liability |
At the commencement date, the lessee measures the lease liability at the present value of all future lease payments.
ROU Asset — Initial Measurement
Para 24 of IFRS 16 sets out the components of the ROU asset at initial recognition: ROU Asset Cost = Initial lease liability ± Lease payments made at or before commencement date ± Initial direct costs incurred by the lessee ± Estimated restoration / dismantling costs (if obligated) - Less: Lease incentives received |
📋 Initial direct costs: Incremental costs of obtaining the lease that would not have been otherwise incurred. E.g. Solicitor fees directly relating to the lease negotiation needs to be included. While general overhead allocation costs are to be excluded. |
Depreciation of the ROU Asset
The ROU asset is depreciated on a straight-line basis (unless another method better reflects the pattern of consumption) over the shorter of the lease term and the remaining useful life of the underlying asset, unless there is reasonable certainty of ownership transfer at the end of the lease, in which case depreciate over the full useful life. |
Determining the Incremental Borrowing Rate (IBR) in Practice |
The discount rate applied is, in order of preference:
Interest rate implicit in the lease if it can be readily determined; or
Incremental borrowing rate (IBR), the rate the lessee would pay to borrow funds to obtain a similar asset over a similar term in a similar economic environment.
The IBR is not a single rate applied uniformly across all leases. It should reflect the rate the lessee would pay to borrow funds of a similar amount, over a similar term, with similar security, in the same currency and economic environment as the lease.
This means:
A 10-year property lease in GBP will carry a different IBR to a 3-year vehicle lease in EUR.
For lease modifications, the IBR at the modification date applies to the remeasurement.
Group treasury or external advisers typically derive IBRs from observable market data: risk-free rate + entity credit spread + term adjustment + currency adjustment.
📑 Documentation matters Auditors require contemporaneous evidence of how each IBR was determined. Business Central stores one rate per lease. Your supporting documentation must sit alongside it in your audit file. |
Worked Example — Lease Liability & ROU Asset Calculation |
⚙️ Key Assumptions
|
Step 1 : Present Value of 60 Monthly Lease Payments
Discount factor formula: 1 ÷ (1 + 0.003125) ^n where n = month number
Year-band colour key:
Year 1 Mths 1–12 · £25,000/month | Year 2 Mths 13–24 · £27,500/month | Year 3 Mths 25–36 · £30,250/month | Year 4 Mths 37–48 · £33,275/month | Year 5 Mths 49–60 · £36,603/month |
◀ Months 1 – 30 | Months 31 – 60 ▶ | ||||||
|---|---|---|---|---|---|---|---|
Mth | Lease Pmt (£) | Disc. | PV (£) | Mth | Lease Pmt (£) | Disc. | PV (£) |
Year 1 · Months 1–12 · £25,000/month | Year 3 · Months 25–36 · £30,250/month | ||||||
1 | 25,000.00 | 0.9969 | 24,922.12 | 31 | 30,250.00 | 0.9078 | 27,461.15 |
2 | 25,000.00 | 0.9938 | 24,844.48 | 32 | 30,250.00 | 0.9050 | 27,375.60 |
3 | 25,000.00 | 0.9907 | 24,767.08 | 33 | 30,250.00 | 0.9022 | 27,290.32 |
4 | 25,000.00 | 0.9876 | 24,689.93 | 34 | 30,250.00 | 0.8993 | 27,205.30 |
5 | 25,000.00 | 0.9845 | 24,613.01 | 35 | 30,250.00 | 0.8965 | 27,120.55 |
6 | 25,000.00 | 0.9815 | 24,536.33 | 36 | 30,250.00 | 0.8938 | 27,036.06 |
Year 1 · Months 1–12 · £25,000/month | Year 4 · Months 37–48 · £33,275/month | ||||||
7 | 25,000.00 | 0.9784 | 24,459.90 | 37 | 33,275.00 | 0.8910 | 29,647.02 |
8 | 25,000.00 | 0.9753 | 24,383.70 | 38 | 33,275.00 | 0.8882 | 29,554.66 |
9 | 25,000.00 | 0.9723 | 24,307.74 | 39 | 33,275.00 | 0.8854 | 29,462.59 |
10 | 25,000.00 | 0.9693 | 24,232.01 | 40 | 33,275.00 | 0.8827 | 29,370.81 |
11 | 25,000.00 | 0.9663 | 24,156.52 | 41 | 33,275.00 | 0.8799 | 29,279.31 |
12 | 25,000.00 | 0.9633 | 24,081.27 | 42 | 33,275.00 | 0.8772 | 29,188.10 |
Year 2 · Months 13–24 · £27,500/month | Year 4 · Months 37–48 · £33,275/month | ||||||
13 | 27,500.00 | 0.9602 | 26,406.87 | 43 | 33,275.00 | 0.8744 | 29,097.17 |
14 | 27,500.00 | 0.9573 | 26,324.61 | 44 | 33,275.00 | 0.8717 | 29,006.52 |
15 | 27,500.00 | 0.9543 | 26,242.60 | 45 | 33,275.00 | 0.8690 | 28,916.16 |
16 | 27,500.00 | 0.9513 | 26,160.85 | 46 | 33,275.00 | 0.8663 | 28,826.08 |
17 | 27,500.00 | 0.9483 | 26,079.35 | 47 | 33,275.00 | 0.8636 | 28,736.28 |
18 | 27,500.00 | 0.9454 | 25,998.11 | 48 | 33,275.00 | 0.8609 | 28,646.76 |
Year 2 · Months 13–24 · £27,500/month | Year 5 · Months 49–60 · £36,603/month | ||||||
19 | 27,500.00 | 0.9424 | 25,917.12 | 49 | 36,602.50 | 0.8582 | 31,413.27 |
20 | 27,500.00 | 0.9395 | 25,836.38 | 50 | 36,602.50 | 0.8556 | 31,315.41 |
21 | 27,500.00 | 0.9366 | 25,755.89 | 51 | 36,602.50 | 0.8529 | 31,217.85 |
22 | 27,500.00 | 0.9337 | 25,675.65 | 52 | 36,602.50 | 0.8502 | 31,120.60 |
23 | 27,500.00 | 0.9308 | 25,595.67 | 53 | 36,602.50 | 0.8476 | 31,023.65 |
24 | 27,500.00 | 0.9279 | 25,515.93 | 54 | 36,602.50 | 0.8449 | 30,927.00 |
Year 3 · Months 25–36 · £30,250/month | Year 5 · Months 49–60 · £36,603/month | ||||||
25 | 30,250.00 | 0.9250 | 27,980.08 | 55 | 36,602.50 | 0.8423 | 30,830.66 |
26 | 30,250.00 | 0.9221 | 27,892.92 | 56 | 36,602.50 | 0.8397 | 30,734.61 |
27 | 30,250.00 | 0.9192 | 27,806.03 | 57 | 36,602.50 | 0.8371 | 30,638.86 |
28 | 30,250.00 | 0.9163 | 27,719.40 | 58 | 36,602.50 | 0.8345 | 30,543.42 |
29 | 30,250.00 | 0.9135 | 27,633.05 | 59 | 36,602.50 | 0.8319 | 30,448.27 |
30 | 30,250.00 | 0.9106 | 27,546.96 | 60 | 36,602.50 | 0.8293 | 30,353.42 |
TOTAL — Undiscounted | £1,831,530.00 | Net Present Value | £1,655,869.00 | ||||
Step 2: Initial ROU Asset Cost
Component | Amount (£) |
Initial lease liability (PV of lease payments) | 1,655,869 |
Add: Initial direct costs (Solicitor fees) | 3,470 |
Less: Lease incentive received | Nil |
ROU Asset — Initial Cost | £1,659,339 |
Monthly Depreciation Charge £1,659,339 ÷ 60 months = £27,656 per month This straight-line depreciation charge is posted every month over the 60-month lease term, reducing the ROU asset from £1,659,339 to nil at the end of Month 60. |
Step 3 : Opening Journal Entry at Commencement Date
Account Narration | Debit (£) | Credit (£) |
Right-of-Use Asset (Dr) | 1,659,339 | |
Lease Liability (Cr) | 1,655,869 | |
Cash / Accruals: Solicitor Fees (Cr) | 3,470 | |
Total | 1,659,339 | 1,659,339 |
Subsequent Measurement: Each Reporting Period |
After commencement, both the lease liability and the ROU asset are updated each period using the effective interest method. There are four steps to perform at each reporting date:
# | Step | What happens | Journal entry |
|---|---|---|---|
1 | Unwind interest on the lease liability | Apply the discount rate to the opening lease liability balance. Recognised in profit or loss as a finance cost. | Finance cost Dr Lease liability Cr |
2 | Record the cash payment | Reduce the lease liability by the actual lease payment made. The payment splits between interest (already accrued in step 1) and principal repayment. | Lease liability Dr Bank Account Cr |
3 | Charge depreciation on the ROU asset | Straight-line over the lease term (or useful life, whichever is shorter). | Depreciation exp Dr ROU Accumulated Depreciation Cr |
4 | Reassess at each reporting date | If a significant event or change in circumstances triggers reconsideration of lease term or variable payments, remeasure the liability and adjust the ROU asset accordingly. |
📈 Front-loaded cost profile: Unlike an operating lease under IAS 17 (which carried a flat straight-line cost), IFRS 16 produces a front-loaded P&L charge. Interest is highest in early years, so the total charge to P&L is higher at the start of the lease and decreases over time, even though the cash payments to the lessor remain constant throughout. |
Real-world leases changes: Lease Modifications & Reassessments |
IFRS 16 distinguishes between two types of post-commencement change, each treated differently.
Reassessments: No Change to Contractual Terms
If circumstances change such that the lessee's assessment of lease term or variable payments changes. E.g., a previously uncertain extension option is now reasonably certain to be exercised, the lessee remeasures the lease liability using a revised discount rate and adjusts the ROU asset accordingly. |
Modifications: Change to Contractual Terms
A lease modification is a change in scope or consideration that was not part of the original terms. There are two treatments:
Scenario | Treatment |
|---|---|
Modification grants an additional right-of-use not in the original lease AND is priced at standalone price | Treat as a separate new lease. Account for the modification independently from the original lease. |
All other modifications (e.g. extending the lease term, reducing scope, changing payment terms) | Remeasure the lease liability at a revised discount rate (IBR at modification date). Adjust the ROU asset by the same amount. Any difference recognised in P&L only if scope reduction exceeds the asset carrying amount. |
⚠️ Modification vs Reassessment: Key Distinction Modification: requires a change in contractual terms (signed addendum, side letter, etc.) Reassessment: involves a change in the lessee's estimate, such as deciding an extension option is now reasonably certain to be exercised. |
➡️ Up Next Post 3: Business Central Setup for IFRS 16
Chart of accounts structure, posting groups, leasing parameters, and how to configure the Asset Leasing module in Dynamics 365 Business Central before processing the first lease transaction.
📝 This post reflects the author's professional views and is for informational purposes only. It does not constitute legal, financial, or accounting advice.