• Companion guide: this walks through the actual arithmetic behind IFRS 16 lease accounting — initial measurement, the amortization schedule, and the split between interest expense and principal repayment — building directly on the concepts explained in “IFRS 16 Lease Accounting and Right of Use Asset.”
• Initial measurement: the lease liability is the present value of unpaid lease payments, discounted at the rate implicit in the lease or, if that can’t be readily determined, the lessee’s incremental borrowing rate.
• Right-of-use asset: initially equals the lease liability, plus any payments made at or before commencement, initial direct costs, and estimated restoration costs, less any lease incentives received.
• Two separate schedules: the lease liability is amortized like a loan (effective interest method); the right-of-use asset is depreciated on a straight-line basis (in most cases) over the shorter of the lease term and the asset’s useful life.
• Common error: depreciating the right-of-use asset using the same declining pattern as the liability’s interest charge — the two follow different, independent schedules.

Worked Example 1: A Simple Five-Year Office Lease

A company enters a five-year lease for office space with annual payments of $50,000, payable in arrears at the end of each year. The rate implicit in the lease is not readily determinable, so the company uses its incremental borrowing rate of 6%. There are no initial direct costs, lease incentives, or restoration obligations.

Step 1 — Measure the lease liability. The lease liability equals the present value of the five $50,000 payments, discounted at 6%:

• PV factor for an ordinary annuity of 5 payments at 6% ≈ 4.2124
• Lease liability = $50,000 × 4.2124 ≈ $210,618

Step 2 — Measure the right-of-use asset. With no additional costs or incentives, the right-of-use asset equals the initial lease liability: $210,618.

Step 3 — Build the liability amortization schedule. Each year, interest accrues on the opening balance at 6%, and the payment reduces the balance by the difference between the payment and the interest charge:

• Year 1: opening balance $210,618; interest $12,637; payment $50,000; closing balance $173,255
• Year 2: opening balance $173,255; interest $10,395; payment $50,000; closing balance $133,650
• Year 3: opening balance $133,650; interest $8,019; payment $50,000; closing balance $91,669
• Year 4: opening balance $91,669; interest $5,500; payment $50,000; closing balance $47,169
• Year 5: opening balance $47,169; interest $2,831; payment $50,000; closing balance $0 (rounding)

Step 4 — Depreciate the right-of-use asset. With a five-year lease term and no purchase option expected to be exercised, the asset is depreciated straight-line over five years: $210,618 ÷ 5 = $42,124 per year, identical in each of the five years — a flat line, unlike the declining interest charge on the liability.

Worked Example 2: Adjusting for a Lease Incentive

Now suppose the same lease includes a one-time incentive: the landlord pays the tenant $15,000 shortly after the lease commences, to help offset fit-out costs.

• The lease liability calculation is unaffected by the incentive — it’s still based purely on the present value of the lease payments the lessee owes: $210,618.
• The right-of-use asset, however, is reduced by the incentive received: $210,618 − $15,000 = $195,618.
• Annual depreciation changes accordingly: $195,618 ÷ 5 = $39,124 per year.

This distinction — that incentives adjust the asset but not the liability — is one of the most frequently misapplied rules in practice, because it’s tempting to net the incentive against the lease payments themselves rather than treating it as a separate adjustment to the right-of-use asset’s initial cost.

Worked Example 3: A Lease With an Extension Option the Lessee Is Reasonably Certain to Exercise

A retailer leases a shop for an initial non-cancellable term of 3 years at $80,000 per year, with an option to extend for a further 2 years at the same rate. At commencement, based on the retailer’s investment in fit-out and the strength of the location, management concludes it is reasonably certain to exercise the extension option.

• Lease term used for measurement: 5 years (3 non-cancellable + 2 extension, because the extension is reasonably certain) — not just the 3-year non-cancellable period.
• The lease liability and right-of-use asset are both measured using all 5 years of payments, discounted at the applicable rate, following exactly the same present-value mechanics as Example 1.
• If management’s assessment later changes — for example, a significant change in circumstances makes exercising the option no longer reasonably certain — the lease liability and right-of-use asset are remeasured using the revised lease term at that point, not restated retrospectively.

Reading the Amortization Schedule in Practice

A well-built lease schedule should let a preparer answer four questions at a glance for any reporting date: the current lease liability balance (split between current and non-current portions for the balance sheet), the current right-of-use asset carrying amount, the interest expense for the period, and the depreciation expense for the period. Keeping the liability schedule and the depreciation schedule as two clearly separate columns — rather than one blended “lease expense” line — is what makes variable-rate remeasurements, partial terminations, and modifications tractable later, since each schedule can be adjusted independently without having to unpick a combined number.

Common Calculation Mistakes

• Using the wrong annuity type — confusing payments made in advance (annuity due) with payments made in arrears (ordinary annuity) changes the present value calculation and must match the actual payment terms in the lease.
• Netting a lease incentive against the liability instead of reducing the right-of-use asset, which misstates both the balance sheet and the interest expense going forward.
• Depreciating over the wrong period — using the full extension-inclusive lease term for depreciation when transfer of ownership isn’t expected, when the shorter of the lease term and useful life should govern (in most straightforward operating-type arrangements, this is simply the lease term itself).
• Forgetting to remeasure when a significant event changes the assessment of whether an extension or termination option will be exercised, which requires updating both the liability and the right-of-use asset at the date of the change, not just adjusting future depreciation.
• Rounding compounding errors across a long amortization schedule — always let the final period’s interest be a plug to bring the liability to exactly zero (or the guaranteed residual value, if any) rather than compounding a rounded rate forward blindly.