What is lease liabilities?

Lease liabilities sit at the centre of modern lease accounting requirements. They represent the payments that a business must make for leased assets during the lease term. These assets can include buildings, equipment, vehicles or technology that the organisation does not own outright but uses for operational purposes.

Standards such as IFRS 16 and FRS 102 ensure that lease obligations are disclosed transparently. This change has improved comparability between organisations and increased visibility of long-term commitments. It has also increased the administrative burden on finance teams who must calculate, manage and disclose these liabilities.

Many organisations now rely on specialist tools to support effective lease accounting. Technology helps simplify reporting, reduce errors and manage the growing requirements of modern lease management. With accurate data and automated calculations, businesses can focus more on decision-making and less on manual reconciliation.

Understanding lease liabilities under IFRS 16 and FRS 102

Lease liabilities reflect the present value of future payments owed under a lease. They arise whenever a company gains the right to use an asset without purchasing it. The liability shows a contractual obligation that spans the lease term.

IFRS 16 requires almost all leases to be recognised on the balance sheet. This includes property leases and equipment leases across many industries. According to the IFRS Foundation, the adoption of IFRS 16 significantly improved transparency by bringing billions of pounds in off-balance-sheet leases into financial reporting globally.

FRS 102 applies a different approach. Finance leases result in recognition of lease liabilities. Operating leases do not. Some organisations reporting under FRS 102 choose to apply the IFRS 16 principles to align with group reporting or internal policies. Consistency helps reduce confusion and improves the clarity of consolidated accounts.

Understanding the standard applied is essential. Each framework has different rules for calculation and disclosure. This affects financial ratios, borrowing assessments and investor perceptions.

How to calculate lease liabilities

The calculation of lease liabilities follows a structured approach under IFRS 16 and where applicable, FRS 102. The goal is to determine the present value of future lease payments. This ensures that financial statements reflect the true economic cost of the lease.

First, businesses must identify all relevant lease payments. These include fixed payments, variable payments tied to an index and expected residual value guarantees. Payments relating to optional extensions must be included when the organisation is reasonably certain it will exercise the option.

Second, the discount rate must be selected. When available, the rate implicit in the lease should be used. If this rate cannot be determined, the lessee’s incremental borrowing rate is applied. The choice of rate has a direct impact on the value of the liability.

Third, the lease term must be defined. This requires considering non-cancellable periods and assessing optional periods based on expected behaviour. Judgement is required especially when lease extensions are common in the business.

Fourth, the present value formula is applied. Each payment is discounted using the chosen rate. The sum of these discounted payments becomes the lease liability on the balance sheet.

A simple example illustrates the process. A business paying £20,000 per year for five years, discounted at 5 percent, records the present value of those payments as its lease liability. This figure usually differs from the total cash paid over the contract, as discounting reduces the future amounts to today’s equivalent value.

Lease liability vs right-of-use (ROU) asset

Lease liabilities and right-of-use assets arise together but represent different aspects of the same contract. The lease liability reflects the payment obligation. The ROU asset reflects the value of the right to use the leased asset during the contract term.

The ROU asset is initially measured using the lease liability as a starting point. It then adjusts for initial direct costs and any incentives received. It is depreciated over the shorter of the lease term or the asset’s useful life.

The lease liability decreases as payments are made. A portion of each payment reduces the principal, while the remainder represents interest expense. This pattern creates a declining liability balance over the life of the contract.

Difference between lease liabilities and ROU assets

These two components work together to show the full economic impact of a lease on financial statements. Their interaction also affects financial ratios such as ROA, debt-to-equity and EBITDA.

Common challenges in managing lease liabilities

Many organisations encounter difficulties when managing lease liabilities. One of the most frequent issues is incomplete or inaccurate lease data. Not all contracts are standardised and important clauses can easily be missed during manual reviews.

Another challenge involves remeasurement requirements. IFRS 16 requires liabilities to be updated whenever key elements change. These include lease extensions, rent indexation or revised payment schedules. Tracking these events manually is time-consuming and error-prone.

Discount rate selection also causes complexity. Many businesses lack documented policies for setting rates. Inconsistent application leads to irregularities across the portfolio and raises audit concerns.

Large lease portfolios add further strain. Each asset may have multiple payment streams, optional periods and indexation rules. Without automation, teams spend significant time reconciling schedules and preparing disclosures.

Finally, regulatory deadlines create pressure. Financial statements must reflect up-to-date data. Any delays in processing lease modifications affect audit outcomes and overall compliance.

Recommended strategies for accurate lease liability accounting

Successful lease liability management requires structured processes, consistent methodologies and reliable systems. The following strategies help organisations improve accuracy and reduce risk.

Centralise all lease information in a single system
This ensures consistent data and reduces duplication and also improves communication between finance, property and procurement teams.

Standardise discount rate methodologies
Clear documentation helps ensure that rates are applied consistently. Regular reviews maintain alignment with market borrowing conditions.

Perform scheduled remeasurements
Lease terms, index-linked payments and extension decisions must be reassessed promptly. Regular reviews strengthen compliance and improve audit readiness.

Automate repetitive calculations
Automated tools reduce manual work and help prevent errors. They also produce standardised disclosure reports required for financial statements.

Provide training for finance teams
Understanding IFRS 16 and FRS 102 requirements supports better judgement and more accurate decision-making. Training also helps staff recognise when to trigger remeasurement.

These strategies follow best practice guidance from the IFRS Foundation and the UK’s Financial Reporting Council. Each body highlights the importance of accuracy, transparency and consistency in financial reporting.

How MRI Software supports lease liability management

MRI Software provides lease accounting software designed to simplify lease accounting and support compliance. The platform automates complex calculations required under IFRS 16 and FRS 102. This includes the calculation of lease liabilities, ROU assets and ongoing remeasurements.

The system stores all documentation in one place. This improves data integrity and strengthens audit trails. Finance teams spend less time gathering information and more time analysing results.

MRI Software supports automated modification events. These include indexation changes, term adjustments and revised payment schedules. Automation ensures liabilities are recalculated accurately and on time.

The platform also integrates with wider lease management workflows. This ensures that operational decisions flow into financial reporting processes without delay. It also improves communication between departments.

In addition, MRI Software helps organisations respond to rising lease accounting demands. Complex portfolios become easier to manage. Reporting becomes more consistent and compliance risk is reduced.

Lease liabilities are an essential element of financial reporting. They reflect the present value of payments that a business must make during a lease. IFRS 16 and FRS 102 have increased the visibility of these obligations across financial statements.

Accurate calculation and ongoing management are critical. Many organisations face challenges with data quality, discount rate selection and remeasurement. Structured processes and modern automation help reduce these risks.

MRI Software supports end-to-end lease liability management. It provides automation, accuracy and robust reporting that help businesses stay compliant. As regulatory expectations continue to evolve, reliable solutions become increasingly important for organisations of all sizes. To learn more about how our tools can help your organisation succeed in managing lease liabilities effectively, contact us today on +44 (0)20 3861 7100.

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