Why IFRS 16 changed lease accounting

Before 2019, operating leases stayed off balance sheet. A company simply expensed lease payments as they were incurred. For IT businesses, where Class-A office space and data-centre rentals can represent a material cost item, this distorted the picture of financial position.

IFRS 16 changed the approach fundamentally: almost all leases are now recognised on the lessee's balance sheet. The distinction between operating and finance leases disappears for the lessee — there is now a single model.

What sits on the balance sheet now

The lessee recognises two new items. A right-of-use asset reflects the lessee's right to use the underlying asset over the lease term. A lease liability represents the present value of future lease payments discounted at an appropriate rate.

In profit or loss, instead of a single rental expense, the lessee now reports depreciation of the right-of-use asset and interest expense on the liability. Total expense over the lease term is broadly similar, but the profile changes: costs are higher at the start of the lease and lower towards the end.

Specifics for IT companies

The most typical lease contracts in the Ukrainian IT sector are Class-A and Class-B offices, coworking arrangements (where the term exceeds 12 months and a specific space is identified), data centres, server racks and test equipment.

Colocation contracts deserve special attention: it is important to determine whether the supplier transfers the right to control a specific asset (a rack, a section of the hall) or simply provides a service. If it is a service, IFRS 16 does not apply. If the customer effectively controls the use of a specific asset, it is a lease.

Measuring the liability and the right-of-use asset

The lease liability is measured as the present value of future lease payments. The discount rate is usually the lessee's incremental borrowing rate — the rate at which the company could borrow funds for a similar term against similar collateral.

The right-of-use asset at commencement equals the lease liability plus any payments made before commencement, plus initial direct costs, plus the estimate of dismantling costs, minus any incentives received from the lessor.

Common mistakes

In practice, Ukrainian companies tend to make several recurring mistakes:

  • using the NBU policy rate instead of the incremental borrowing rate,
  • failing to separate service components (utilities, cleaning) from lease payments,
  • not remeasuring the liability when contract terms change,
  • ignoring extension options when there is reasonable certainty of exercise,
  • overlooking lease payment indexation.

Short-term and low-value leases

IFRS 16 allows two exemptions. If the lease term is 12 months or less and the contract contains no purchase option, the lessee can avoid recognising an asset and liability and instead expense the payments on a straight-line basis. The same applies to leases of low-value assets (as a rule of thumb, an asset worth no more than around USD 5,000 when new).

For IT companies, this is relevant for laptops, monitors and small office equipment. Server hardware and office premises do not qualify for these exemptions.

Conclusion

IFRS 16 has put significant amounts on the balance sheets of Ukrainian IT companies that used to remain invisible. This affects key metrics: EBITDA, leverage, return on assets.

Investors and auditors expect to see the standard applied correctly with a complete contract register, justified rates and documented judgements. Building all of this in the week before an audit is difficult, so lease accounting should be set up as an ongoing process.