The Impact of IFRS 16 on Corporate Balance Sheets: A Case Analysis of Lease Liabilities

Accounting standards play a central role in shaping how companies present their financial position and performance. The introduction of IFRS 16 – Leases in January 2019 represented one of the most significant changes in corporate accounting in decades. By requiring lessees to capitalize almost all leases on their balance sheets, IFRS 16 eliminated the long-standing distinction between operating and finance leases. The standard aimed to improve transparency, comparability, and faithful representation of lease obligations. However, its application has had substantial consequences for reported assets, liabilities, and performance metrics. This paper examines these consequences, with an emphasis on balance sheet expansion, income statement adjustments, and leverage ratios, supported by empirical evidence and a worked calculation.

Conceptual Background of IFRS 16

Under the previous standard, IAS 17, leases were classified as either finance leases, recognized on the balance sheet, or operating leases, disclosed only in notes. This enabled firms in sectors such as retail, airlines, and transport to keep significant obligations off the balance sheet. IFRS 16 corrected this by requiring lessees to recognize a right-of-use (ROU) asset and a corresponding lease liability for most lease agreements.

The lease liability is initially measured as the present value of future lease payments, discounted at the lessee’s incremental borrowing rate. The ROU asset is recognized at the same amount, adjusted for prepaid or accrued lease payments. Over time, the liability is reduced by principal payments while accruing interest expense, and the ROU asset is depreciated, replacing straight rental expense with depreciation plus interest.

Empirical Evidence on Balance Sheet Effects

Several studies and professional surveys have quantified the transition impact of IFRS 16:

1. A review of European firms indicated average increases of 19.6% in assets and 59.7% in liabilities after capitalization of operating leases, demonstrating the material leverage effect (ifrs.org, 2025).
2. PwC’s global survey found that adoption led to a median EBITDA increase of 13% and a median reported debt increase of 22%, with the magnitude highest among retailers and airlines (PWC, 2016).
3. EY highlighted sector differences: airlines and retail companies saw asset increases of about 14%, compared to only 6% in telecommunications, reflecting industry dependence on leasing (Chan, 2025).

These statistics confirm that IFRS 16 not only reshaped accounting presentation but also altered performance indicators such as leverage, return on assets, and EBITDA margins.

Worked Example: Lease Liability Recognition

Consider a company entering IFRS 16 transition with a five-year lease obligation of annual payments of $1,000,000. If the incremental borrowing rate is 5%, the initial lease liability is the present value of future payments:

PV=1,000,000/(1.05)¹+1,000,000/(1.05)²+1,000,000/(1.05)³+1,000,000/(1.05)⁴+1,000,000(1.05)⁵PV=952,381+907,029+863,838+822,703+783,526=4,329,477

If this firm previously disclosed the lease off-balance-sheet, the transition increases reported assets and liabilities by $4.33 million. Assuming pre-IFRS 16 total assets were $20 million and debt was $10 million, the debt-to-equity ratio rises significantly:

• Before IFRS 16: Debt = $10m, Equity = $10m → D/E = 1.0
• After IFRS 16: Debt = $14.33m, Equity still ≈ $10m → D/E ≈ 1.43

This illustrates the leverage effect identified in empirical surveys.

Impact on Income Statement and Ratios

The shift from rental expense to depreciation plus interest expense under IFRS 16 changes income statement profiles. In the example, the annual rental expense of $1 million would disappear. Instead:

• The lease liability accrues interest at 5% = $216,474 in year one.
• The ROU asset depreciates over five years = $865,895 annually.

Total lease-related expense in year one = $1,082,369, slightly higher than the straight-line rent. Over the life of the lease, expenses equalize, but the front-loaded profile means higher early expenses and lower later expenses.

For EBITDA, however, removal of rental expense boosts performance. If EBITDA before IFRS 16 was $2 million, eliminating $1 million of rent lifts it to $3 million, consistent with PwC’s 13% median EBITDA increase finding (PWC, 2016). This materially alters performance metrics, such as EBITDA margin and enterprise value/EBITDA ratios, which are important to investors and lenders.

Sector-Specific Implications

The impact of IFRS 16 has not been uniform. Retailers, airlines, and shipping companies, all with substantial leased assets, reported significant balance sheet expansion. For example, airline companies historically kept aircraft leases off balance sheets; under IFRS 16, billions in ROU assets and liabilities were recognized, altering solvency ratios and potentially triggering debt covenants. By contrast, technology and telecommunications firms saw modest effects, as their lease reliance is lower.

This heterogeneity raises issues of comparability. While transparency improves, sectoral differences in leasing strategies mean investors must carefully interpret ratio changes post-IFRS 16.

Broader Implications and Criticisms

Although IFRS 16 enhances transparency, critics note several issues. The complexity of calculating discount rates introduces estimation subjectivity. Furthermore, the balance sheet inflation may mislead stakeholders who equate accounting debt with financial debt. Some argue that credit analysts already capitalized operating leases informally, meaning IFRS 16 only codified existing practices rather than providing new insights. Nonetheless, for many stakeholders, especially those without advanced analytical resources, the standard improved visibility into companies’ long-term commitments.

Conclusion

The adoption of IFRS 16 represents a landmark reform in lease accounting. By bringing operating leases onto the balance sheet, it increased reported assets and liabilities, boosted EBITDA, and altered leverage and profitability ratios. Empirical evidence shows median asset increases of nearly 20% and liability increases exceeding 50%, with particularly large impacts in retail and airlines. A worked calculation demonstrates how even a modest lease can raise debt-to-equity from 1.0 to 1.43, highlighting the standard’s significance. Despite criticisms about complexity and comparability, IFRS 16 has made financial reporting more transparent and aligned with economic reality.