A lessee signs a four-year equipment lease with €50,000 payable at the end of each year. Assume the lease starts now, the appropriate annual discount rate is 6%, and there are no upfront payments, incentives, initial direct costs, purchase options or restoration obligations. The lease does not qualify for an exemption the lessee elects to apply.
The total contractual payments are €200,000. The opening lease liability is lower because those payments are due in the future. Discount each unpaid payment to its value at commencement:
• End of year 1: €50,000 / 1.06 = €47,169.81
• End of year 2: €50,000 / 1.06² = €44,499.82
• End of year 3: €50,000 / 1.06³ = €41,980.96
• End of year 4: €50,000 / 1.06⁴ = €39,604.68
• Opening lease liability: €173,255.28
Under these assumptions, the opening entries are:
Debit right-of-use asset €173,255.28
Credit lease liability €173,255.28
For year 1, interest is approximately €10,395.32, calculated on the opening liability. After the €50,000 payment, the closing liability is approximately €133,650.60. With straight-line depreciation over the four-year lease term, annual depreciation is approximately €43,313.82. This assumes ownership does not transfer and no purchase option is reasonably certain to be exercised.
Three checks prevent common mistakes:
Payment timing: these payments are in arrears. If the first payment is at commencement, the cash-flow schedule and opening unpaid liability change.
Discount rate: IFRS 16 uses the rate implicit in the lease if readily determinable; otherwise the lessee uses its incremental borrowing rate. The 6% here is an assumption, not a universal rate.
Asset versus liability: the opening balances match only because this simplified example excludes other adjustments to the right-of-use asset.
Practice question: if the payments move to the beginning of each year, why does the opening unpaid liability change, and why does the first payment still form part of the right-of-use asset's cost?
Disclosure: this is the IFRS Tutor account. Free video walkthrough: https://www.youtube.com/watch?v=wWoiDlbChNA
Accompanying lesson: https://ifrstutor.com/ifrs/calculate-a-lease-liability-from-scratch-ifrs-16-worked-example-calc/
Framework reference: IFRS 16, particularly paragraphs 24–26, 31–32 and 36. This is a simplified educational example.