AASB 16 Leases became effective for annual periods beginning on or after 1 January 2019, replacing AASB 117 and eliminating the distinction between finance leases and operating leases for lessees. Under AASB 16, virtually all leases with a term greater than 12 months — office space, warehouse leases, vehicle fleets, equipment hire — appear on the balance sheet. For bookkeepers servicing clients that adopted AASB 16 without specialist advice, unravelling the initial implementation and keeping the ongoing schedules current is one of the more complex tasks in practice.
The Core Principle — Right-of-Use Asset and Lease Liability
At commencement of a lease, a lessee recognises:
- A right-of-use (ROU) asset representing the right to use the underlying asset for the lease term
- A lease liability representing the obligation to make lease payments
Initial measurement of the lease liability:
The lease liability is measured at the present value of future lease payments, discounted at the rate implicit in the lease (if determinable) or the lessee's incremental borrowing rate (IBR).
For most operating entities, the implicit rate is not readily available, so the IBR is used. The IBR is the rate the lessee would pay to borrow funds over a similar term, with similar security, in a similar economic environment. This typically approximates the entity's overdraft rate or a comparable secured lending rate.
Future lease payments:
Year 1: $120,000
Year 2: $120,000
Year 3: $120,000
Year 4: $120,000
Year 5: $120,000
IBR: 5% per annum
PV = $120,000 × PVIFA(5%, 5 years) = $120,000 × 4.329 = $519,480
Initial journal entry:
Dr Right-of-Use Asset $519,480
Cr Lease Liability $519,480
Subsequent Measurement
Lease liability: Each period, the liability is unwound using the effective interest method:
Dr Finance Cost (Interest) $25,974 (5% × $519,480)
Cr Lease Liability $25,974
Dr Lease Liability $120,000
Cr Bank (Lease Payment) $120,000
The liability reduces by the principal component of each payment; the interest component flows through the P&L as finance cost.
ROU asset: Depreciated on a straight-line basis over the shorter of the lease term and the useful life of the underlying asset (if ownership transfers at end of lease, use useful life; otherwise use lease term).
Annual depreciation = $519,480 ÷ 5 years = $103,896
Dr Depreciation — ROU Asset $103,896
Cr Accumulated Depreciation — ROU $103,896
The total P&L charge in year 1 = $103,896 depreciation + $25,974 finance cost = $129,870. Compare to the cash lease payment of $120,000. Under AASB 16, the P&L charge in early years exceeds the cash payment because of the front-loaded interest — a common surprise for clients.
Practical Expedients
AASB 16 provides two practical expedients that exempt certain leases from on-balance-sheet recognition:
Short-Term Leases (12 Months or Less)
Where the lease term at commencement is 12 months or less (including renewal options the lessee is reasonably certain to exercise), the lessee may elect to expense lease payments on a straight-line basis, without recognising an ROU asset or lease liability.
The election is made by class of underlying asset.
Low-Value Assets
Where the underlying asset, when new, has a value of approximately USD 5,000 (approximately AUD 7,500) or less, the lessee may elect to expense payments on a straight-line basis. Examples: tablets, laptops, small office furniture, personal computers.
The low-value asset exemption applies on an asset-by-asset basis, regardless of materiality to the entity overall.
Variable Lease Payments
Only fixed lease payments (and in-substance fixed payments) are included in the lease liability measurement. Variable payments linked to an index or rate (e.g., CPI-linked rent reviews) are included using the index at commencement; those linked to usage or performance (e.g., turnover rent) are excluded entirely.
When a lease modification occurs (e.g., rent review based on CPI), the lease liability is remeasured using the updated payments and the same IBR (unless the modification is a new lease). This triggers a corresponding adjustment to the ROU asset.
EBITDA Impact
AASB 16 significantly affects EBITDA because what was previously an operating lease expense (above EBIT) is replaced by:
- Depreciation (still above EBITDA)
- Finance cost (interest, below EBIT)
This means EBITDA improves under AASB 16 for entities with material operating leases, even though total P&L cost and total cash outflow are unchanged. Bookkeepers should alert clients that EBITDA-based loan covenants may have been affected — many banking covenants use lease-adjusted EBITDA or specifically carve out AASB 16 impacts.
Simplified Reporting Entity Exemptions
Tier 2 (Simplified Disclosure) entities under AASB 1060 must apply AASB 16, but with reduced disclosure requirements. There is no exemption from recognition.
Small proprietary companies that do not prepare financial statements under the Corporations Act 2001 s 292 have no statutory obligation to apply AASB 16. However, where financials are prepared for a bank or investor, lenders increasingly request AASB 16-compliant statements.
For entities that choose not to apply AASB 16 (e.g., because they prepare only management accounts), bookkeepers should maintain a separate lease schedule so that the impact can be quantified if required.
Building a Lease Register
Every entity with material leases should maintain a lease register containing:
- Lease commencement date and term
- Option periods and assessment of whether reasonably certain to exercise
- Fixed payments schedule (including escalation clauses)
- IBR applied at commencement
- Opening ROU asset and lease liability balances
- Monthly amortisation and depreciation schedule
- Remeasurement events (modifications, reassessments)
A lease register is not a luxury — it is the working document that supports every balance sheet figure and every note disclosure. Without it, the audit trail does not exist.
Key Reference Points
- AASB 16 Leases — the standard
- AASB 1060 — general purpose financial statements: Simplified Disclosures Standard
- AASB 117 — superseded leases standard (for transitional reference)
- Corporations Act 2001 s 292 — financial reporting obligations for proprietary companies
- ATO TR 2021/2 — income tax treatment of right-of-use assets (AASB 16 does not change income tax treatment — deductions remain based on lease payments, not depreciation and interest)
- IFRS 16 — international equivalent (virtually identical to AASB 16)