- Under IFRS 16 a business renting its office puts the lease on its balance sheet: a right-of-use asset and a lease liability, both starting at the present value of the rent.
- In the example, five years of £100k rent discounted at 6% gives a £421.2k asset and liability.
- The cost is front-loaded: £109.5k in year 1 (depreciation £84.2k plus interest £25.3k) against £100k of rent, falling to £89.9k in year 5. Over the five years the total matches the rent: £500k.
- EBITDA rises by the full £100k, because rent is replaced by depreciation and interest, which both sit below EBITDA.
- UK GAAP (FRS 102) moves to a similar on-balance-sheet model for periods starting on or after 1 January 2026.
Before IFRS 16, an office lease was usually an operating lease: rent went through the profit and loss account as an expense, and nothing went on the balance sheet. IFRS 16 Leases changed that for lessees. Most leases now create a right-of-use asset and a lease liability. This post follows one illustrative office lease through its five years.
The lease: a business rents an office for five years from 1 January 2026, paying £100,000 at the end of each year. There are no break clauses, incentives or upfront costs, and the business's incremental borrowing rate (what it would pay to borrow a similar amount over a similar term) is 6%.
Day one: an asset and a liability
The lease liability is the present value of the five payments, discounted at 6%: £421.2k. The right-of-use asset starts at the same amount, because there are no upfront payments, incentives or direct costs to add or deduct.
| When | Entry | Debit | Credit | £k |
|---|---|---|---|---|
| 1 Jan 2026 | Start of the lease | Right-of-use asset | Lease liability | 421.2 |
| Year 1 | Depreciation (straight line over 5 years) | Depreciation expense | Right-of-use asset | 84.2 |
| Year 1 | Interest at 6% | Interest expense | Lease liability | 25.3 |
| 31 Dec 2026 | Pay the year's rent | Lease liability | Cash | 100.0 |
The cost is front-loaded
Depreciation is the same every year, £84.2k. Interest is charged on the liability that's still outstanding, so it's highest in year 1 (£25.3k) and lowest in year 5 (£5.7k). The total expense starts above the rent and ends below it: £109.5k in year 1 against £89.9k in year 5. Over the full five years, depreciation and interest add up to exactly the £500k of rent paid.
The asset falls faster than the liability
The right-of-use asset is depreciated in a straight line, but the liability falls slowly at first, because most of each early payment is interest. In the middle years the liability is larger than the asset, which reduces net assets until the lease ends and both reach zero.
What it does to EBITDA, profit and cash flow
Rent used to be an operating expense above EBITDA. Under IFRS 16 it's replaced by depreciation and interest, both of which sit below EBITDA, so EBITDA rises by the whole £100k. Operating profit rises by £15.8k (rent minus depreciation), and profit before tax falls by £9.5k in year 1 (the extra interest), reversing in later years.
The cash paid doesn't change: £100k a year. But the cash flow statement splits it. The principal part of each payment (£74.7k in year 1) is a financing cash flow. The interest part (£25.3k) is classified as operating or financing under the company's IAS 7 policy; the chart assumes operating. Either way, operating cash flow rises, which is worth knowing when comparing companies or reading covenants.
Exemptions and UK GAAP
- Short-term leases of 12 months or less, and low-value assets, can stay off the balance sheet, with the rent expensed as before.
- Break clauses and extension options change the lease term, and therefore the liability, depending on whether the business is reasonably certain to use them.
- UK GAAP: for periods starting on or after 1 January 2026, FRS 102 brings most leases onto the balance sheet in a similar way, with some simplifications, such as using an obtainable borrowing rate.
The details depend on each lease's terms, so check them with your auditor.
Make these charts with your own numbers
Finance teams use charts like these to explain lease accounting to boards, lenders and budget holders. Paste a lease schedule into the stacked bar chart, the waterfall chart or the diverging bar chart and download it as an image, video or PowerPoint slide.
Sources and method
Illustrative example, not advice. A five-year office lease from 1 January 2026 with £100,000 paid at the end of each year, no incentives, initial direct costs or options, discounted at a 6% incremental borrowing rate. The right-of-use asset is depreciated in a straight line over five years. Monthly balances accrue interest at the equivalent monthly rate. The cash flow comparison assumes interest paid is classified as an operating cash flow (IAS 7 allows operating or financing).