Are there hidden accounting risks in your leasing contracts? The accounting standard IFRS 16 has increased transparency but also the complexity for lessees. This guide shows you how to master the accounting treatment of property leases and accurately assess your assets.
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The topic briefly and concisely
IFRS 16 ends off-balance sheet reporting for lessees and requires the recognition of a right-of-use asset and a lease liability for almost all contracts.
The change leads to a balance sheet extension and significantly affects key figures such as EBITDA, gearing ratio, and equity ratio.
Exceptions only apply to short-term contracts (≤12 months) and low-value goods (<5,000 USD), while complex cases like sale-and-lease-back require particularly careful scrutiny.
Did you know that before the introduction of IFRS 16, around 85% of all lease obligations did not appear on company balance sheets? This lack of transparency ended on 1 January 2019, when the new standard fundamentally changed the accounting treatment of real estate leases. For lessees, this means recognising a right-of-use asset and a lease liability for almost all contracts. This transition has far-reaching consequences for balance sheet metrics, from the equity ratio to EBITDA. As a property owner or investor, you must understand these changes to accurately assess the financial health of a portfolio or company. This article guides you through the key aspects of IFRS 16.
The End of Off-Balance Sheet Accounting: The Core Change of IFRS 16
The biggest revolution brought about by IFRS 16 is the elimination of the distinction between operating leases and finance leases for the lessee. Under the old standard, IAS 17, companies could record real estate leases as operating expenses without them appearing on the balance sheet. Since 2019, lessees must recognise a right-of-use asset and a corresponding lease liability on the balance sheet for virtually every lease contract. This has led to a significant extension of the balance sheet for many companies and made previously "invisible" obligations amounting to a global total of USD 3.3 trillion visible. The change ensures greater comparability between companies that purchase their assets and those that lease them. The differences between IFRS and HGB are significant here because the HGB still allows an off-balance treatment. This new transparency is the first step towards a more informed analysis of real estate assets.
Assessment of Usage Rights: How to Set the Value Correctly
The correct assessment of the right-of-use asset is a multi-stage process. The initial measurement of the lease liability is done at the present value of future lease payments, discounted with the interest rate underlying the contract. If this cannot be determined, the lessee's incremental borrowing rate should be used. The right-of-use asset itself is recognised at this liability value, plus some additional items.
The following components are included in the initial measurement of the right-of-use asset:
The amount of the initially assessed lease liability.
Lease payments made before or at the commencement of the contract, less incentives received.
Initial direct costs of the lessee, such as brokerage fees of 3%.
Estimated costs for dismantling the property at the end of the term.
Precisely recording these values is crucial, as they directly affect the amount of future depreciation. An accurate fair value property valuation according to IFRS forms the basis for sound accounting. The complexity of this valuation highlights the need for data-driven analysis.
Practical Exceptions: When IFRS 16 Does Not Need to Be Applied
Although the principle of recognition applies to nearly all lease contracts, the IASB has permitted two practical exemptions as an option. These exceptions significantly reduce the administrative burden for certain types of contracts. Companies can exercise these options separately for each asset class.
The two exceptions to the recognition requirement are:
Short-term leases: Contracts with a term of 12 months or less that do not include a purchase option do not need to be recognised.
Low-value leases: Leased items with a new value of less than 5,000 USD can also be exempted. In real estate, this more likely pertains to the rental of individual office furniture or technical equipment.
The use of these options can reduce the complexity in contract management by up to 15%, depending on the portfolio. However, for all other contracts, particularly long-term real estate leases, the recognition requirement remains and requires careful examination of the IFRS disclosure requirements in real estate valuation. Thorough documentation of the decision for or against the application of the option is essential for audit security.
Impact on Financial Metrics: What Changes for Investors
Activating leases has substantial impacts on key financial metrics (KPIs). As the previous rental expense is replaced by interest and depreciation, EBITDA (earnings before interest, taxes, and depreciation) mathematically increases. At the same time, the extension of the balance sheet leads to higher indebtedness and potentially a lower equity ratio. This can affect loan covenants tied to such metrics. An increase in the balance sheet total by 10-20% is not uncommon in leasing-intensive companies.
The main shifts include:
Increase in EBITDA: Operational lease costs are eliminated, enhancing earnings before interest, taxes, and depreciation.
Higher leverage: The new lease liability increases financial debt.
Altered income statement: Instead of a linear rental expense, there is a decreasing total expense consisting of interest and depreciation (front-loading effect).
Increased fixed assets: The right of use increases the total assets on the balance sheet.
An EBITDA increase of 25% can make a company appear more attractive but conceals the increased indebtedness. The analysis of the tax implications of IFRS property valuation becomes even more crucial. For a quick assessment of such effects, our ImmoGPT chat can offer an initial orientation.
Special Case Sale-and-Lease-Back: Creating liquidity while maintaining control of the balance sheet
A sale-and-leaseback transaction, where a property is sold and immediately leased back, is a popular financing option. Under IFRS 16, the accounting treatment crucially depends on whether the sale meets the criteria of performance obligation under IFRS 15. Only if control over the asset actually transfers to the buyer may the seller-lessee derecognise the property from their balance sheet. Any profit from the sale may also be realised only for the portion of rights that is transferred to the buyer. The retained portion is recognised as a right-of-use asset in the seller's balance sheet. Errors in the assessment can lead to incorrect profit realisation and faulty balance sheet representation. The complexity of such transactions often requires detailed assessment of property lease agreements under IFRS. An independent, AI-supported evaluation by Auctoa safeguards your decisions here and creates transparency.
Conclusion: IFRS 16 requires proactive management and precise assessment
The accounting treatment of real estate leasing under IFRS 16 has changed financial reporting significantly. The recognition of nearly all leasing arrangements enhances transparency but also increases complexity for property owners and investors. An accurate understanding of the valuation logic, exemptions, and impacts on financial metrics is essential. Proactive contract management and precise, data-driven evaluation are the keys to successfully mastering the requirements of IFRS 16. The new rules are more than just an accounting exercise – they are a crucial factor for the strategic management of real estate assets. Take advantage of a non-binding Auctoa evaluation now to gain clarity on your leasing values.
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Additional useful links
The Federal Ministry of Finance publishes a statement from the German Accounting Standards Committee (DRSC) on the draft law for global minimum taxation for multinational corporate groups.
Another statement from the DRSC on the discussion draft of the law adapting the Minimum Tax Act is also available via the Federal Ministry of Finance.
The German Accounting Standards Committee (DRSC) provides information here about its current projects in the leasing sector.
The official website of the International Financial Reporting Standards (IFRS) Foundation provides detailed information on the IFRS 16 standard for leases.
A Wikipedia article offers a comprehensive overview of the IFRS 16 standard on leases.
EY Germany discusses IFRS 16 leases and current leasing innovations in an article.
KPMG Austria provides information about recent changes to the IFRS 16 standard in an article.
The NWB Database offers a detailed entry on the accounting of leases according to IFRS 16.
Haufe offers an article on the accounting of lease assets according to HGB, IFRS, and EstG.
IAS Plus by Deloitte provides comprehensive information on IFRS 16 (leases), including details, interpretations, and developments.
FAQ
Do lessors also need to change their accounting under IFRS 16?
No, for lessors (landlords), the regulations remain largely unchanged. They must continue to distinguish between operating leases and finance leases, as was already the case under the old standard IAS 17.
What is included in the calculation of the lease liability?
The lease liability includes the present value of future lease payments. This includes fixed payments, variable payments depending on an index or rate, residual value guarantees, and the exercise price of a purchase option when its exercise is reasonably certain.
What is the difference in the treatment of real estate leases between IFRS 16 and HGB?
The main difference is that under IFRS 16, almost all leases must be accounted for by the lessee on the balance sheet (on-balance). In the German Commercial Code (HGB), operating leases are still not reported on the balance sheet, and the payments are recorded as current expenses (off-balance).
What does the "front-loading effect" mean in IFRS 16?
The "front-loading effect" describes the decreasing trend of the total expense from a lease contract in the profit and loss account. As the interest component is calculated on the declining lease liability, the interest expense is higher at the beginning of the term and decreases over time. Therefore, the total expense (interest + depreciation) is initially higher than towards the end of the term.
How can Auctoa help me with IFRS 16 valuation?
Auctoa offers AI-powered real estate valuations that provide a swift and data-driven basis for determining the fair value of usage rights. This creates transparency and supports you in meeting the complex valuation requirements of IFRS 16, especially for large portfolios or sale-and-leaseback transactions.
