Lease measurement: why the liability and right-of-use asset differ
A lessee can correctly recognise an £81,697 lease liability and an £87,697 right-of-use asset on the same day. The liability measures unpaid lease payments. The asset also includes qualifying costs already paid, net of incentives received. Under UK-adopted full IFRS, starting both schedules at the same amount without checking those adjustments can miss part of the asset cost.
Date the lease and list the unpaid payments
IFRS 16 recognises the liability and right-of-use asset at commencement, when the underlying asset is made available for use. Signing a contract is not automatically commencement. The assessed term includes the non-cancellable period and relevant extension or termination-option periods where the required reasonable-certainty tests are met.
Measure the liability as the present value of lease payments unpaid at commencement. Use the implicit rate if readily determinable; otherwise use the lessee's incremental borrowing rate. The payment list can include more than stated fixed rent, such as in-substance fixed payments, index-linked amounts using the commencement index and specified option or guarantee amounts.
This article assumes the contract already contains a lease, that recognition exemptions are not elected and that the right-of-use asset uses the cost model. It does not apply FRS 102, US GAAP or a public-sector valuation policy.
Build the asset from the liability
Right-of-use cost begins with the initial liability. Add payments made at or before commencement, deduct incentives received and add qualifying initial direct costs. Those direct costs must be incremental costs that would not have arisen without obtaining the lease; a legal or administration invoice does not qualify merely because it concerns the contract.
Qualifying restoration obligations can also enter asset cost, measured under IAS 37. They remain separate from the unpaid lease payments used to measure the lease liability.
A three-year equipment lease
All amounts, dates and rates are hypothetical. Equipment becomes available on 1 January 2026 for three years. Three £30,000 payments fall due at each year-end. Assume a supported 5% annual incremental borrowing rate because the implicit rate is not readily determinable.
There are no options, guarantees, indexation, variable payments, non-lease components, restoration obligations or impairment. At commencement the lessee also pays £5,000 prepaid rent and £2,000 qualifying direct costs, and receives a £1,000 incentive. There are no further incentives. Tax entries are omitted, not assumed nil in actual accounts.
The liability is £30,000 / 1.05 + £30,000 / 1.05² + £30,000 / 1.05³ = £81,697.44. Asset cost is £81,697.44 + £5,000 - £1,000 + £2,000 = £87,697.44.
The initial future-payment entry is Dr right-of-use asset £81,697.44; Cr lease liability £81,697.44. The net £6,000 of other commencement cash costs and receipts increases the asset, without increasing that liability.
| Initial right-of-use cost bridge | Amount |
|---|---|
| Present value of unpaid payments | £81,697.44 |
| Add prepaid rent | £5,000 |
| Deduct incentive received | £1,000 |
| Add qualifying direct costs | £2,000 |
| Initial right-of-use asset | £87,697.44 |
Sources and context, checked :
Run interest and depreciation separately
Year-one interest is £81,697.44 × 5% = £4,084.87. Record Dr finance cost and Cr lease liability for that amount. The £30,000 payment then debits the liability and credits bank, leaving £55,782.31 owed.
Assume the asset has a three-year useful life, no ownership transfer or purchase option, nil residual value and straight-line consumption. Annual depreciation is £87,697.44 / 3 = £29,232.48, leaving £58,464.96 after year one. Record depreciation expense and accumulated depreciation separately from liability interest.
IFRS 16 requires impairment assessment and remeasurement for specified changes. Keep the dated payment list, rate evidence and asset-cost reconciliation together, then update the liability and depreciation schedules separately when facts change. Their closing balances need not match.
Sources and context, checked :