IFRS 16 offers exemptions for low-value assets and short-term leases, helping businesses streamline lease accounting and reduce administrative burden. However, careful application is key to avoiding compliance risks.
International Financial Reporting Standard 16 (IFRS 16) offers specific exemptions for leases classified as low-value or short-term. These exemptions can simplify lease accounting under IFRS 16 by allowing some leases to remain off the balance sheet. Yet companies must apply them carefully to avoid compliance risks.
Several major audit firms have analyzed these exemptions. Their findings emphasize accurate IFRS 16 lease classification, consistent documentation, and clear reporting of lease activities to ensure compliance with IFRS 16 and present an accurate financial picture.
In this article, we aim to offer a practical and easy-to-read overview of the core principles, the potential risks, and the best ways to handle these exemptions in practice. Our research is based on thought leadership from the major audit firms.
IFRS 16 requires businesses to present most lease agreements on the balance sheet, which affects key metrics such as EBITDA and leverage ratios. However, there are exemptions: the IFRS 16 short-term lease exemption and the IFRS 16 low-value asset exemption. By using these, a company can expense lease payments directly in the income statement instead of capitalizing them. This reduces administrative tasks but demands rigorous tracking of lease terms, asset values, and disclosures to stay within compliance with IFRS 16.
Companies see these exemptions as a practical way to simplify their financial reporting. Still, applying IFRS 16 exemptions calls for vigilance. Low-value assets must be measured at their original cost, and short-term leases must fulfill strict limits on duration. Businesses also need robust documentation to show why a lease qualifies as short-term or low-value, especially if its term or use changes later. Internal controls and a clear methodology are vital for organizations that want to apply IFRS 16 exemptions successfully.
Under IFRS 16, each lease is typically recognized on the balance sheet as a right-of-use asset and a corresponding lease liability. Two noteworthy exceptions can reduce the financial impact of IFRS 16 exemptions:
Both aim to streamline lease accounting for assets or contracts with minor financial significance. However, companies must ensure that each lease genuinely qualifies and keep records of all decisions to maintain compliance with IFRS 16.
Low-value assets are generally those worth about EUR 5,000 or less when new. The assessment depends on the original manufacturing cost, not the price your organization might have paid second-hand. For instance, a printer’s current value may be low, but if it was considerably more expensive when new, it could exceed the threshold your company set.
IFRS 16 also requires that low-value assets be largely independent. If multiple components function as one larger system, exceeding the low-value limit, the exemption might not apply. Although individual leases may qualify, the total financial impact of IFRS 16 exemptions for many small leases can be substantial, so companies must assess potential materiality in aggregate.
An additional consideration is subleasing: if a firm subleases an asset, the original lease may lose its low-value status. Establish clear guidelines for deciding when a lease meets the low-value criteria. This ensures consistent lease classification, robust documentation, and ongoing compliance with IFRS 16.
The IFRS 16 short-term lease exemption applies to leases of 12 months or less with no purchase option. Instead of capitalizing the agreement, the firm expenses lease payments straight to the income statement over the lease period. This approach can be particularly appealing for companies with many small, short-lived contracts.
However, accurate term estimation is critical. The duration includes non-cancellable periods plus any extension or termination options the lessee is reasonably certain to exercise. If new terms cause a lease to continue beyond a year, or an extension is formally (or informally) granted, the exemption may no longer apply. When that happens, the lease liability under IFRS 16 must be recognized from the date the contract changed.
Short-term leases can reduce the administrative load of applying IFRS 16, but they still require tight controls and regular reviews. Companies need clear procedures to track expiration dates and detect any lease modifications that might disqualify them from this exemption.
Although IFRS 16 exemptions can make lease accounting more manageable, they also pose potential hazards. Mistakes in applying exemptions can lead to understated liabilities, financial misstatements, or compliance violations. Two key risk areas stand out.
Companies sometimes classify leases as short-term when a renewal is virtually guaranteed. Under IFRS 16, all probable extensions should be reflected in the lease term. Similarly, an asset might be labeled as “low value” using its current market price, not the original manufacturing cost. Both errors distort the true financial impact of IFRS 16 exemptions and might result in inaccurate disclosures. Frequent reviews and robust processes can mitigate the risk of classifying leases incorrectly.
IFRS 16 demands ongoing evaluation. A lease starting as 12 months may be extended to 18 months, which triggers capitalization from the date of change. Meanwhile, large clusters of low-value leases might collectively become material, requiring enhanced disclosures. Failure to adjust for changes can violate compliance with IFRS 16 and force restatements. Tracking modifications, renewals, or new usage terms is vital to ensure the exemptions remain valid.
Major firms and IFRS 16 guidance documents propose several best practices to apply IFRS 16 exemptions properly:
Strong internal controls and thoughtful planning reduce the risks of IFRS 16 lease exemptions. Companies that invest in these capabilities are less likely to face compliance issues or surprise audit findings.
IFRS 16 exemptions allow companies to exclude certain leases from the balance sheet, potentially easing administrative burdens. Short-term leases (up to one year) and low-value assets (under a set threshold) are two key ways to limit recognized lease liability under IFRS 16. However, applying these exclusions takes careful planning and monitoring.
Organizations must confirm each lease meets the criteria, track changes to the lease term, and consider whether many small leases create a material effect on their financial statements. Regular reevaluation, plus clear documentation of each classification decision, is the surest route to compliance with IFRS 16 and transparent reporting.
By embracing best practices—like assigning firm thresholds, centralizing lease data, and scheduling periodic reviews—companies can effectively apply IFRS 16 exemptions. The financial impact of IFRS 16 exemptions may reduce the complexity of lease accounting, but it does not lessen the importance of accuracy and internal oversight. With thoughtful strategies and ongoing vigilance, businesses can benefit from the exemptions while maintaining consistent, reliable disclosures.