How to account for operating leases

Accurate lease accounting is essential for commercial property managers. Operating leases impact financial reporting, cash flow management and compliance with international accounting standards. The introduction of IFRS 16 has changed how these leases appear on balance sheets, requiring careful tracking and precise calculations. Understanding these requirements ensures financial transparency and minimises compliance risks.

Managing leases effectively requires the right technology. MRI Software provides advanced lease management and lease accounting software for property owners to help automate reporting and maintain compliance. Our lease administration services offer expert support in tracking lease obligations, ensuring accurate financial statements and reducing administrative workload. With the right tools, you can simplify operating lease accounting and focus on optimising your portfolio.

Table of contents:

• Understanding operating lease accounting under IFRS
• Key differences between operating and finance leases
• How IFRS 16 impacts lease accounting
• Best practices for compliance with lease accounting standards
• How MRI Software helps streamline operating lease accounting

Understanding operating lease accounting under IFRS

Operating leases have traditionally been treated as off-balance sheet items, allowing businesses to expense lease payments without recognising liabilities. However, changes in lease accounting standards under International Financial Reporting Standards (IFRS) have significantly altered this approach.

Under IFRS 16, lessees are now required to recognise nearly all leases on the balance sheet as liabilities, with a corresponding right-of-use asset. This change eliminates the previous distinction between operating and finance leases for lessees, making lease obligations more transparent.

Commercial property managers must understand these regulations to ensure proper financial reporting and compliance.

Key differences between operating and finance leases

While both operating and finance leases involve the use of an asset over a defined period, they differ in financial treatment, risk allocation and impact on financial statements.

• Ownership transfer: A finance lease often results in the transfer of ownership at the end of the lease term, whereas an operating lease does not.
• Asset recognition: Finance leases require the lessee to recognise both an asset and a liability on the balance sheet, while operating leases historically allowed for off-balance sheet reporting (now changing under new standards).
• Depreciation and interest expenses: Finance leases include depreciation and interest expenses, whereas operating leases involve straight-line lease expense recognition.

For property managers, understanding these distinctions helps with structuring agreements in a way that aligns with financial goals and regulatory requirements.

How IFRS 16 impacts lease accounting

New lease accounting standards have significantly altered the way operating leases are reported, bringing them onto balance sheets in most cases. This shift increases transparency but also affects financial ratios and debt calculations.

Balance sheet and income statement considerations for operating leases

Under IFRS 16, lessees must record operating leases as liabilities, which impacts key financial metrics such as leverage ratios and net income calculations. These changes can influence loan covenants and investor perceptions of a company’s financial health.

On the income statement, lease expenses for operating leases remain straight-line over the lease term. This differs from finance leases, where depreciation and interest expenses are recorded separately, leading to higher front-loaded expenses.

For property managers, these reporting changes may affect tenant decision-making, particularly in industries where balance sheet management is a key financial strategy. Understanding these shifts allows for better structuring of lease agreements to meet both property managers and tenant needs.

How to properly record lease expenses and liabilities

Accurate lease expense recording is essential for compliance. Under the new standards, lease liabilities must be recognised at the present value of future lease payments, with right-of-use assets recorded separately.

Key considerations include:

• Discount rate selection: Choosing an appropriate discount rate to calculate present value.
• Lease term determination: Assessing whether renewal options should be included in lease calculations.
• Expense recognition: Ensuring straight-line expense recognition for operating leases to maintain compliance.

Maintaining detailed records and applying consistent methodologies is crucial to avoiding misstatements in financial reports.

Best practices for compliance with lease accounting standards

To ensure compliance with lease accounting standards, commercial property managers should adopt best practices that improve accuracy and efficiency.

1. Maintain centralised lease data: Keeping all lease agreements in one place ensures easy access to terms, payment schedules and key financial data.
2. Regularly review lease agreements: Assessing lease structures helps identify risks and opportunities for optimisation.
3. Use technology for automation: Implementing lease accounting software reduces manual errors and streamline reporting.
4. Monitor changes in accounting standards: Staying updated on regulatory changes helps avoid compliance issues and ensures best practices are followed.

By integrating these practices, property managers can improve financial reporting, reduce risk and ensure adherence to evolving lease accounting standards.

How MRI Software helps streamline operating lease accounting

Managing lease accounting manually can be complex and time-consuming, especially with evolving compliance requirements. MRI Software offers lease accounting software designed to simplify lease management and financial reporting.

With MRI Software, you can:

• Automate lease calculations and financial reporting.
• Ensure compliance with IFRS 16 regulations.
• Centralise lease data for better accuracy and visibility.

To learn more about how MRI Software can support your lease accounting needs, contact our team on +44 (0)20 3861 7100.