IFRS 16 requires lessees to recognise a lease liability and a matching right-of-use asset for most leases, replacing the previous operating lease off-balance-sheet model. The International Accounting Standards Board IFRS Foundation explains that the liability is measured at the present value of lease payments and the asset at cost less depreciation and any impairment, changing the balance sheet and the pattern of profit and expense recognition.
Recognition and measurement
Recognition moves obligations that were previously hidden from the balance sheet into a reported liability. Depreciation of the right-of-use asset is recorded in operating results while interest on the lease liability is recorded in finance costs. Deloitte notes that this dual effect changes both the level and the composition of reported profit and loss and cash flow items, with direct consequences for financial ratios.
Effects on common debt ratios
Capitalising leases increases on-balance-sheet liabilities and total assets, so debt-to-assets and debt-to-equity typically rise because the numerator increases and equity can be affected by changed profit recognition. At the same time EBITDA usually increases because lease payments that were previously operating expenses are replaced by depreciation and interest and depreciation is excluded from EBITDA. PwC highlights that the increase in EBITDA reduces ratios that use EBITDA as a denominator, so debt-to-EBITDA can improve or deteriorate depending on the relative size of the newly recognised liability and the EBITDA uplift.
The practical consequence is that covenant compliance, credit ratings and borrowing capacity are affected. Lenders and borrowers have responded by renegotiating covenant definitions to exclude IFRS 16 lease liabilities or to use adjusted debt measures. Jurisdictional and industry context matters because leasing intensity varies across sectors and because many territories follow IFRS while the United States uses US GAAP with a similar but distinct approach under ASC 842.
Beyond numbers, there are human and cultural implications. Companies in asset-light industries such as retail or aviation face larger balance sheet changes, which can influence management compensation tied to leverage metrics and alter stakeholders’ perceptions of risk. Environmental and territorial considerations arise when lease capitalisation affects financing for green projects in emerging markets, where covenant flexibility can determine access to capital.