IFRS 16 took effect for accounting periods beginning on or after 1 January 2019. Six full reporting cycles later, the standard is now the settled framework against which any lease versus buy decision in an IFRS reporter is presented. The headline change is well rehearsed: operating leases that previously sat off-balance-sheet now appear as a right-of-use asset on the asset side and a lease liability on the funding side, with depreciation and interest replacing what was a single operating lease expense. The mechanics are not in dispute.
What is more contested, and less carefully argued in most management papers, is whether IFRS 16 actually changes the underlying lease versus buy recommendation. A short audit, then, of where the new accounting moves the answer and where the answer was always the same.
What the pre-IFRS 16 default actually was
Before 2019, the operating lease was, for many corporates, the structurally preferred answer to a use-of-asset question, and the preference was not driven by economics alone. Three features of the previous framework produced a bias toward leasing.
First, the operating lease did not appear on the balance sheet. The note disclosure of future minimum lease payments was there for the diligent analyst, but the headline gearing ratio, the return-on-capital-employed figure and the asset turnover ratio all flattered the lessee. For a covenanted borrower close to a gearing trigger, that mattered. For a listed business whose remuneration framework rewarded return on capital, it mattered more.
Second, the operating lease produced a single expense line and a clean cash outflow. The accounting was simpler, the audit was lighter, and the management commentary did not have to engage with the financing structure of the asset base.
Third, the operating lease commonly carried optionality (break clauses, extension options, indexation) that an owned asset did not. That optionality had a value, and the value was real, but in the pre-IFRS 16 world it was rarely priced explicitly.
The result, in practice, was that lease versus buy memos were often presented as a balanced economic comparison and decided as a balance sheet outcome. Management knew this. Lenders knew this. The standard-setters knew this, which is why the standard changed.
Where IFRS 16 actually changes the answer
The standard removes the off-balance-sheet treatment for almost all leases above 12 months and above a low value threshold. The right-of-use asset is recognised at the present value of the lease payments, adjusted for initial direct costs, prepayments and restoration provisions. The lease liability is recognised at the same present value. Both unwind over the lease term: the asset by depreciation, the liability by interest and principal.
For the lease versus buy decision, three consequences follow that materially shift the recommendation.
Covenant headroom is no longer a hidden benefit
The most common pre-2019 rationale for leasing (preserving reported gearing ratios) has disappeared for almost all material leases. A 10-year property lease that was previously invisible on the balance sheet now appears as a multi-million-pound liability that any lender, rating agency or covenant calculation has to engage with. Where covenant headroom was the unstated driver of a lease decision, the post-IFRS 16 comparison removes the rationale. The economic case has to stand on its own.
Return on capital metrics now move in the same direction
Pre-IFRS 16, leasing flattered return on capital employed because the denominator excluded the leased asset. Post-IFRS 16, the right-of-use asset sits in the denominator and ROCE behaves much more like it does under ownership. Remuneration frameworks, internal hurdle rates and divisional capital allocation systems that were calibrated to flatter the leased outcome now produce a more comparable read across the two routes. Where the remuneration construction was driving the decision, that driver is gone.
The front-loaded P and L expense is real
Under the previous standard, an operating lease produced a level expense over the lease term. Under IFRS 16, the combination of straight-line depreciation and an interest expense that is higher in the early years produces a front-loaded total charge. For a business with a young lease portfolio (the lessee that has just signed a 15-year property lease, or the operator rolling over a fleet) the reported operating profit in years one to three is lower than it would have been under the previous standard, and lower than the equivalent purchase-and-depreciate alternative on a like-for-like basis. Earnings-sensitive decisions (covenant compliance on an interest-cover basis, dividend cover calculations, equity story narratives) are now materially affected by the lease versus buy choice in a way they were not before.
Where the answer has not changed
The more important observation, and the one that tends to be glossed in the management deck that proposes to revisit the corporate's leasing policy in light of the new standard, is that the underlying economic question is unchanged. IFRS 16 is an accounting reform. It does not alter the cash flows, the tax treatment, the operational flexibility or the residual value exposure attached to either route.
Three features of the old comparison are exactly as they were.
- The cash flow profile. The lessee still pays rent on the contractual schedule. The buyer still pays the purchase price and then operates the asset. The choice between them is a choice between two cash flow streams; the present value comparison, run at a consistent discount rate, produces the same answer before and after IFRS 16.
- The tax treatment. Lease rentals remain deductible for corporation tax in the jurisdictions where they were deductible before. Capital allowances on owned assets remain available where they were before. The tax shield is unchanged by the accounting reform and should be modelled on its own terms.
- The residual value position. The lessee carries no residual value risk; the buyer does. That economic exposure is what it always was, and IFRS 16 does not move it. The lease carrying optionality (a break clause that lets the lessee walk away from an asset whose useful life has shortened) retains that optionality and its value.
The lease versus buy decision, properly framed, was always a comparison of two streams of cash flows, two tax positions, two operational flexibility profiles and two risk allocations. That framing is unchanged. What has changed is the visibility of the financing implicit in the leasing route, and that visibility has removed a set of accounting-driven distortions rather than introduced new economic considerations.
What the corrected appraisal should show
Where IFRS 16 actually changes the lease versus buy recommendation in our experience, it does so in three specific situations.
- The corporate whose lease policy was driven by covenant or remuneration optimisation. Post-IFRS 16, those drivers are gone, and the economic comparison usually now favours buying for long-duration assets where the corporate has the capital to deploy.
- The corporate close to a covenant trigger on a gearing or interest-cover basis. The lease liability is now in the gearing ratio and the front-loaded interest expense is now in the interest-cover ratio. The lease versus buy decision becomes a covenant-sensitivity exercise rather than an accounting-presentation exercise.
- The corporate with an earnings-sensitive equity story. The front-loaded P and L profile under IFRS 16 produces materially different reported operating profit in the early years of a large new lease, and the management narrative has to engage with that.
Outside those three situations, the lease versus buy answer post-IFRS 16 is, on a defensible appraisal, the same answer it was pre-IFRS 16, run on the same economics. The frequent claim in management decks that "the standard has changed our leasing economics" usually means, on inspection, that the standard has removed an accounting benefit the corporate was relying on without saying so. That is a useful disclosure but not, in itself, an economic shift.
The standard moved the accounting. The economics of the choice between owning and leasing an asset were the same before the standard moved and they are the same after. The committee that reads the post-IFRS 16 paper as a fresh economic comparison is being asked to revisit a question whose answer, on the cash flows, has not changed.
The committee question
One test is worth applying to any post-IFRS 16 lease versus buy memo. Ask the team to present the comparison on a pre-tax cash flow basis, with the same discount rate applied to both routes, and to identify separately the elements of the recommendation that rest on accounting presentation rather than on cash. If the recommendation survives that separation, it is an economic recommendation. If it does not, the committee is being asked to take a position on accounting optics, and that is a different question that deserves a different conversation.
IFRS 16 has done useful work in surfacing what was always there. The corporate that uses the new standard as a prompt to re-examine its lease portfolio is doing the right thing; the corporate that concludes the underlying economics have changed is reading the standard for more than it actually says.