Lease accounting in the books of lessee under NFRS 16 is one of the most important and frequently examined topics for CA students in Nepal and finance professionals alike. If you are preparing for ICAN exams or trying to apply NFRS 16 correctly in practice, this guide is for you. NFRS 16 (Nepal Financial Reporting Standard 16) mirrors IFRS 16 and completely changed how lessees recognise, measure, and present leases. We cover everything from core concepts to journal entries to a full numerical example so you can master this topic with confidence.
The Core Shift: Operating Lease vs. Finance Lease under NFRS 16
Before NFRS 16, lease accounting in Nepal followed NAS 17 (Nepal Accounting Standard 17), which divided leases into two categories for the lessee:
- Finance Lease is recognised on the balance sheet
- Operating Lease is treated as a simple rental expense (off-balance sheet)
This distinction created a major problem. Companies could structure leases as ‘operating’ to keep significant liabilities off their balance sheets, giving a misleading picture of their financial position.
NFRS 16 eliminated this distinction for lessees entirely.
Under NFRS 16, almost all leases must now be recognised on the balance sheet. The lessee must record:
- A Right-of-Use (ROU) Asset: representing the right to use the leased asset
- A Lease Liability: representing the obligation to make future lease payments
Pro-Tip for Exam Students: The operating vs. finance lease distinction still exists, but only for lessors, not lessees. In the lessee’s books, there is now only one model. Click here to learn more about the lessor’s books.
Identifying a Lease and Key Definitions
Before applying NFRS 16, you must determine whether a contract is or contains a lease.
A contract is (or contains) a lease if it conveys the right to control the use of an identified asset for a period of time in exchange for consideration.
Control means the customer has:
- The right to obtain substantially all the economic benefits from use of the asset, AND
- The right to direct the use of the asset throughout the period of use
Key Terms to Know:
| Term | Definition |
|---|---|
| Commencement Date | The date the lessor makes the underlying asset available for use by the lessee |
| Lease Term | The non-cancellable period of a lease, plus optional extension/termination periods if reasonably certain |
| Incremental Borrowing Rate (IBR) | The rate of interest the lessee would pay to borrow funds to obtain an asset of similar value over a similar term |
| Right-of-Use Asset | An asset representing the lessee’s right to use an underlying asset for the lease term |
| Lease Liability | The present value of lease payments not yet made |
Recognition Exemptions for Lessees
NFRS 16 provides two practical expedients, situations where a lessee does NOT need to recognise an ROU asset and lease liability on the balance sheet. Instead, lease payments are recognised as an expense on a straight-line basis over the lease term.
Short-Term Leases
Leases with a lease term of 12 months or less (including renewal options) qualify as short-term leases. The lessee can elect not to recognize these on the balance sheet. Examiner’s Tip: This election is made by class of underlying asset, not lease by lease.
Leases of Low-Value Assets
Leases where the underlying asset has a low value when new, typically assets worth USD 5,000 or less, qualify for this exemption. Examples include:
- Tablets and personal computers
- Small items of office furniture
- Telephones
Examiner’s Tip: Low-value assessment is done on an absolute basis, regardless of whether the amounts are material to the lessee’s financial statements. A large company can still apply this exemption for small laptops.
Accounting Treatment for Both Exemptions: Recognise lease payments as an expense on a straight-line basis over the lease term (similar to old operating lease treatment under NAS 17).
Initial Measurement Lease Accounting in the Books of Lessee
At the commencement date, the lessee must put the lease on the balance sheet. This involves two calculations.
Step 1: Calculating the Lease Liability for Lease Accounting in the Books of Lessee
The Lease Liability is initially measured at the present value of unpaid lease payments, discounted using:
- The interest rate implicit in the lease (if it can be readily determined), OR
- The lessee’s incremental borrowing rate (IBR) if the implicit rate cannot be determined
Lease payments included in the measurement:
| Included | Not Included |
|---|---|
| Fixed payments (less any lease incentives receivable) | Variable payments not based on an index |
| Variable payments based on an index or rate | Contingent rent |
| Expected amounts payable under residual value guarantees | |
| Exercise price of a purchase option (if reasonably certain) | |
| Penalties for termination (if reflected in the lease term) |
Formula:
Lease Liability = PV of all future lease payments discounted at implicit rate or IBR
Step 2: Calculating the Right-of-Use (ROU) Asset for Lease Accounting in the Books of Lessee
The Right-of-Use Asset is initially measured at cost, which comprises:
ROU Asset = Initial Lease Liability
+ Lease payments made on or before commencement date
- Lease incentives received
+ Initial direct costs incurred by the lessee
+ Estimated dismantling / restoration costs (if applicable)
Pro-Tip: Remember — initial direct costs are ADDED to the ROU Asset but do NOT affect the initial Lease Liability.Subsequent Measurement: Amortisation and Interest Expense
After initial recognition, the lessee must account for the lease every period in two ways.
Depreciating the ROU Asset
The Right-of-Use Asset is subsequently measured using the cost model (as per NAS 16 Property, Plant and Equipment), unless the lessee applies the revaluation model.
Under the cost model, the ROU asset is depreciated on a straight-line basis from the commencement date to the earlier of:
- The end of the useful life of the underlying asset, OR
- The end of the lease term
Examiner’s Tip: If there is a reasonable certainty of ownership transfer or purchase option exercise, depreciate over the useful life. Otherwise, depreciate over the lease term.
The ROU Asset is also subject to impairment testing under NAS 36 (Impairment of Assets).
Interest Expense on Lease Liability
The Lease Liability is subsequently measured using the effective interest method:
Closing Liability = Opening Liability + Interest for the period - Lease payment made
Each period:
- Increase the liability by the interest accrued (Opening Balance × IBR)
- Decrease the liability by the cash lease payment made
This creates a classic front-loaded expense pattern. Meaning interest is higher in early years and lower in later years.
Step-by-Step Journal Entries in Lessee Books
Here are the complete journal entries you need to know.
1. At Commencement Date (Initial Recognition)
To record the ROU Asset and Lease Liability:
Dr. Right-of-Use Asset XXX
Cr. Lease Liability XXX
If there are initial direct costs paid in cash:
Dr. Right-of-Use Asset XXX
Cr. Bank / Cash XXX
2. Each Reporting Period: Interest Accrual
To record interest expense on the lease liability:
Dr. Interest Expense (Finance Cost) XXX
Cr. Lease Liability XXX
3. Each Period: Lease Payment Made
To record the actual cash payment:
Dr. Lease Liability XXX
Cr. Bank / Cash XXX
Note: Steps 2 and 3 are often combined in practice. The net effect is: Dr. Interest Expense + Dr. Lease Liability (principal portion), Cr. Bank.
4. Each Period: Depreciation of ROU Asset
To record depreciation charge:
Dr. Depreciation Expense XXX
Cr. Accumulated Depreciation — ROU Asset XXX
Practical Example: NFRS 16 Lease Accounting in the Books of Lessee
Let’s work through a full example to consolidate everything above regarding Lease Accounting in the Books of Lessee:
Scenario
Rajesh Enterprises (based in Kathmandu) enters into a lease for office space on 1 January 2024 with the following terms:
- Annual lease payment: NPR 1,00,000 (paid at the end of each year)
- Lease term: 3 years
- Incremental borrowing rate: 10% per annum
- Initial direct costs paid: NPR 5,000
- No lease incentives received
Step 1: Calculate the Present Value of Lease Liability
PV = 1,00,000 / (1.10)¹ + 1,00,000 / (1.10)² + 1,00,000 / (1.10)³
PV = 90,909 + 82,645 + 75,131
PV = NPR 2,48,685
Step 2: Calculate Initial ROU Asset
ROU Asset = Lease Liability + Initial Direct Costs
= 2,48,685 + 5,000
= NPR 2,53,685
Lease Amortisation Schedule (Lease Accounting in the Books of Lessee)
| Year | Opening Liability (NPR) | Interest @ 10% (NPR) | Payment (NPR) | Closing Liability (NPR) |
|---|---|---|---|---|
| 2024 | 2,48,685 | 24,869 | 1,00,000 | 1,73,554 |
| 2025 | 1,73,554 | 17,355 | 1,00,000 | 90,909 |
| 2026 | 90,909 | 9,091 | 1,00,000 | 0 |
| Total | 51,315 | 3,00,000 | Note: Total interest paid = NPR 51,315 = difference between total payments (3,00,000) and initial liability (2,48,685). ✓ |
Depreciation of ROU Asset
Annual Depreciation = ROU Asset ÷ Lease Term
= 2,53,685 ÷ 3
= NPR 84,562 per year
Journal Entries — Year 1 (2024)
1 January 2024: Initial Recognition:
Dr. Right-of-Use Asset 2,53,685
Cr. Lease Liability 2,48,685
Cr. Bank (initial direct costs) 5,000
31 December 2024: Interest Accrual:
Dr. Interest Expense (Finance Cost) 24,869
Cr. Lease Liability 24,869
31 December 2024: Lease Payment:
Dr. Lease Liability 1,00,000
Cr. Bank 1,00,000
31 December 2024: Depreciation:
Dr. Depreciation Expense 84,562
Cr. Accumulated Depreciation — ROU Asset 84,562
Income Statement Impact: Year 1
| Item | Amount (NPR) |
|---|---|
| Depreciation Expense | 84,562 |
| Interest Expense | 24,869 |
| Total Expense | 1,09,431 |
Presentation and Disclosure Requirements under NFRS 16 for Lease Accounting in the Books of Lessee:
Balance Sheet (Statement of Financial Position)
- ROU Assets must be presented separately from other PPE assets or disclosed in the notes
- Lease Liabilities must be presented separately from other financial liabilities
- Split lease liabilities into current (due within 12 months) and non-current portions
Income Statement
- Depreciation of ROU asset is shown as part of operating expenses
- Interest expense on lease liability is shown separately under finance costs
- These must NOT be combined into a single “lease expense” line
Cash Flow Statement
| Cash Flow | Classification |
|---|---|
| Principal repayment of lease liability | Financing Activities |
| Interest paid on lease liability | Operating or Financing Activities |
| Short-term / low-value lease payments | Operating Activities |
| Variable lease payments (not in liability) | Operating Activities |
Impact on Key Financial Ratios
Understanding the ratio impact is essential for both exam purposes and real-world financial analysis.
| Ratio | Impact of NFRS 16 |
|---|---|
| EBITDA | Increases as lease payment is replaced by depreciation + interest (both below EBITDA) |
| Debt-to-Equity | Increases as lease liabilities are now on the balance sheet |
| Asset Turnover | Decreases as ROU assets increase total assets |
| Interest Coverage | Decreases as interest expense increases |
| Operating Cash Flow | Increases as only interest is in operating activities; principal goes to financing |
Conclusion and Key Takeaways
Lease accounting in the books of the lessee under NFRS 16 / IFRS 16 is a landmark change in financial reporting. Here is what you must remember:
- Almost all leases go on the balance sheet the old off-balance sheet operating lease is gone for lessees
- Two assets are recognized the Right-of-Use Asset and the Lease Liability
- Initial measurement ROU Asset at cost (includes direct costs); Lease Liability at present value of payments
- Subsequent measurement ROU Asset depreciated straight-line; Lease Liability unwound using effective interest method
- Two exemptions exist short-term leases (≤12 months) and low-value asset leases
- Income statement impact depreciation + interest replace the old straight-line rental expense
- Ratio impact EBITDA improves, but leverage ratios worsen
For ICAN exam candidates, focus on mastering the journal entries, the lease amortization schedule, and the initial measurement formulas as these are the most commonly tested areas.
This article is based on NFRS 16 as adopted by the Accounting Standards Board (ASB) Nepal, which is substantially converged with IFRS 16 issued by the IASB.