After commencement day, IFRS 16 runs two machines in parallel. The lease liability accretes interest at your discount rate and shrinks with every payment. The right-of-use asset ignores interest entirely and depreciates straight-line, like any other fixed asset. The two never move in step — and the gap between their movements is exactly why capitalised leases look more expensive in the early years than the rent they replaced. Let's continue the bakery oven example and produce the full schedule.
Engine one: depreciating the asset
The right-of-use asset depreciates over the shorter of the lease term and the asset's useful life — unless ownership transfers to you by the end, in which case it is the useful life. The oven is fit for ten years but leased for five, so five years wins: M45,489.44 ÷ 5 = M9,097.89 of depreciation a year, a clean straight line, immune to interest rates and payment timing.
Engine two: unwinding the liability
Each year the liability opens, accrues interest at 10%, absorbs the payment, and closes. Interest is charged on the *opening balance*, so it starts high and tapers as the balance is paid down. Year one, in journal form: Dr Finance cost M4,548.94 / Cr Lease liability M4,548.94, then Dr Lease liability M12,000 / Cr Bank M12,000.
| Year | Opening (M) | Interest @10% (M) | Payment (M) | Closing (M) | Depreciation (M) | Total expense (M) |
|---|---|---|---|---|---|---|
| 1 | 45,489.44 | 4,548.94 | 12,000.00 | 38,038.38 | 9,097.89 | 13,646.83 |
| 2 | 38,038.38 | 3,803.84 | 12,000.00 | 29,842.22 | 9,097.89 | 12,901.73 |
| 3 | 29,842.22 | 2,984.22 | 12,000.00 | 20,826.44 | 9,097.89 | 12,082.11 |
| 4 | 20,826.44 | 2,082.64 | 12,000.00 | 10,909.08 | 9,097.89 | 11,180.53 |
| 5 | 10,909.08 | 1,090.91 | 12,000.00 | 0.00 | 9,097.89 | 10,188.80 |
Why the expense is front-loaded
Read the last two columns together. Depreciation is flat at M9,097.89, but interest falls from M4,548.94 to M1,090.91, so total expense slides from M13,646.83 in year one to M10,188.80 in year five. Under the old operating-lease model the same oven cost a flat M12,000 a year. Nothing about the lease changed — only the reporting geometry. The practical consequences are worth naming: year-one profit is lower than it used to be, EBITDA is higher all five years (the expense moved below the EBITDA line into interest and depreciation), and any covenant or management bonus keyed to those numbers needs to know which model it was written for.
Over five years the oven costs exactly the same M60,000 of cash under either model. IFRS 16 does not change what you pay — it changes when the profit and loss account is asked to notice.
The three-line monthly routine
Every period after commencement, the whole lease is three entries: depreciation of the right-of-use asset; interest accretion on the liability; the payment itself, splitting into the principal portion that reduces the liability and the interest portion already accrued. On a monthly cadence with an annual-in-arrears example, the split happens through a current/non-current reclass at each reporting date. FinSage posts all three automatically from the lease master record, previews the schedule before anything hits the ledger, and keeps every figure traceable to its rule — which is what your auditor will ask to see.
Next week: the discount rate itself — where an incremental borrowing rate comes from, and how to build one you can defend to an auditor without borrowing the bank's whole treasury department.
Written by the FinSage team
FinSphere Solutions · Maseru, Lesotho · IFRS-compliant cloud accounting for SMEs and practices