You’ve probably signed a lease at some point, maybe for an apartment, a car, or office equipment. But if you’re running a business, leases go far beyond a monthly payment and a signature. They shape how a company’s finances look on paper, how much debt investors think you’re carrying, and what obligations you’re committing to for years ahead. Under modern accounting standards like IFRS 16, businesses are now required to bring most leases onto their balance sheets, a rule that has dramatically changed how companies report their financial position.

In this guide, we’ll walk through exactly what a lease is, how to identify one, who the parties are, how long a lease lasts, and how they’re treated in the books with clear, real-world examples along the way.

What Is a Lease?

At its core, a lease is a contract, or a specific part of a contract, that gives one party the right to use an asset (known as the underlying asset) for a specific period of time in exchange for payment, which is called consideration.

Think of it this way: you’re not buying the thing. You’re buying the right to use it.

The Two Main Parties in a Lease

Every lease involves two key players:

• • The Lessee: The person or company that obtains the right to use the asset.
  • The Lessor: The person or company that owns the asset and provides the right to use it.

Imagine your business needs a delivery truck. Instead of buying one, you sign a 3-year agreement with a local dealership to use one of their trucks for $500 a month. In this scenario, you are the lessee, the dealership is the lessor, the truck is the underlying asset, and the $500 monthly payment is the consideration.

Your company rents an office. It leases vehicles. Maybe it has a long-term equipment hire agreement. Under NFRS 16 (Nepal’s adoption of NFRS 16), most of these arrangements now appear on your balance sheet, whether you’ve recognised them yet or not.

This article explains what NFRS 16 requires, who it applies to in Nepal, and exactly how to account for a lease from Day 1 to final payment.

Does NFRS 16 Apply in Nepal?

Yes, as NFRS 16, under standards issued by the Accounting Standards Board Nepal (ASB Nepal). If you’re a smaller company using NFRS for SMEs or NAS for MEs, a simplified version of lease accounting applies, but the core logic is the same.

What Did NFRS 16 Change?

Before NFRS 16, most leases were operating leases, simply expensed as rent each month, invisible on the balance sheet.

NFRS 16 ended that. Now, as a lessee (someone receiving the ‘leased item’), you must:

1. Recognise a Right-of-Use (ROU) asset (your right to use the leased item)
2. Recognise a Lease Liability (your obligation to pay for it)

This affects your balance sheet, profit, and key financial ratios. If your company’s net profit is pegged to bank covenants or if you are seeking new credit, you need to understand this.

Step 1: Does Your Contract Contain a Lease?

Not every rental or service agreement is a lease under NFRS 16. A contract qualifies as a lease only if it gives you the right to control the use of an identified asset for a period of time in exchange for consideration.

Three conditions must all be met:

① Identified asset: The asset is specifically identified (a named vehicle, a specific office floor). If the supplier can swap it out at will and benefit from doing so, it is not an identified asset. This is called substitution rights. Learn more here.

② You get substantially all economic benefits: You use the asset and capture its output during the contract period.

③ You direct how the asset is used: You decide how and for what purpose the asset is deployed.

What Is an Identified Asset?

The asset in the contract must be explicitly or implicitly specified. But here’s a critical nuance: if the supplier has a substantive substitution right, it is not considered a lease. What does that mean? If your contract simply specifies lets say ‘a truck” and the dealership can freely swap your truck for a different one whenever it’s cheaper or more convenient for them, you don’t truly control a specific asset, and therefore, you don’t have a lease. A substantive substitution right exists when the supplier can realistically and practically substitute the asset, and benefits from doing so. If they can, there’s no identified asset and no lease.

Step 2: What Is the Lease Term?

The lease term is not just the non-cancellable period in your contract. You must also include:

• Renewal periods you are reasonably certain to exercise
• Termination options you are reasonably certain not to exercise

‘Reasonably certain’ is a high bar.

Ask: Would walking away from this lease cost significantly more than staying? If yes, include that renewal period.

Example: A trading company leases a warehouse near Birgunj customs for 3 years, with two optional 2-year renewals. The location is irreplaceable for their operations, and they have always renewed in the past. Result: the lease term for accounting purposes is 7 years (3 + 2 + 2) even though the signed contract is only 3 years.

Getting the lease term wrong is one of the most common audit adjustments under NFRS 16.

Step 3: Calculate the Lease Liability

The lease liability = the present value of all future lease payments, discounted at the appropriate rate.

Discount rate to use: Use the interest rate implicit in the lease if you can determine it. In Nepal, most lease contracts don’t disclose this, so you use your Incremental Borrowing Rate (IBR): the rate at which your company could borrow a similar amount over a similar term from a Nepali bank today.

What payments to include:

• Fixed payments (minus any lease incentives you’ll receive)
• Variable payments linked to an index or rate (e.g., CPI-linked rent escalation)
• Purchase option price, if you’re reasonably certain to exercise it
• Termination penalties, if the lease term assumes early exit

What to exclude:

• Variable payments based on usage (per-km charges, utilities)
• Short-term lease payments, if you elect the practical expedient (see Step 6)
• Low-value asset payments, if you elect the practical expedient

Worked Example: Himalayan Traders Pvt. Ltd.

Present Value Calculation:

PV = 12,00,000 × [(1 − (1.10)⁻⁵) / 0.10] = 12,00,000 × 3.7908 = NPR 45,48,960

This NPR 45.49 lakh is your lease liability on Day 1. Previously, this would have been zero on your balance sheet.

Step 4: Recognise the Right-of-Use Asset

On the commencement date, the ROU asset is measured at:

ROU Asset = Lease Liability + Initial Direct Costs + Prepayments − Lease Incentives Received + Restoration Cost Provision

In our example (no additional items): ROU Asset = NPR 45,48,960

The ROU asset is then depreciated straight-line over the shorter of:

• The lease term, or
• The useful life of the asset (only relevant if ownership transfers to you)

For our 5-year lease: Annual depreciation = 45,48,960 ÷ 5 = NPR 9,09,792

Don’t forget restoration costs. If your lease requires you to restore the premises to original condition, estimate that cost and include it in the ROU asset from Day 1, with a corresponding provision.

Step 5: Journal Entries: Year 1

Commencement date:

Dr  Right-of-Use Asset         45,48,960
    Cr  Lease Liability                     45,48,960

End of Year 1: Interest on lease liability (10% × 45,48,960):

Dr  Finance Cost               4,54,896
    Cr  Lease Liability                     4,54,896

End of Year 1: Lease payment made:

Dr  Lease Liability            12,00,000
    Cr  Cash / Bank                        12,00,000

End of Year 1: Depreciation of ROU asset:

Dr  Depreciation Expense       9,09,792
    Cr  Accumulated Depreciation           9,09,792

Closing lease liability after Year 1: 45,48,960 + 4,54,896 − 12,00,000 = NPR 38,03,856

Repeat for each subsequent year until the liability reaches zero.

Step 6: Practical Expedients (What You Can Skip)

NFRS 16 allows two expedients that reduce the compliance burden:

Short-term leases (12 months or less): Elect not to recognise an ROU asset or lease liability. Instead, expense payments are straight-lined. This election is made per class of asset, not lease by lease.

Low-value assets: Low-value assets can stay off-balance sheet regardless of the lease term. NFRS 16 does not define a specific threshold. The IASB indicated in its Basis for Conclusions that assets worth approximately USD 5,000 or less when new would typically qualify. This has become the widely accepted benchmark in practice, but your accounting policy must document your judgment.

Both expedients are widely used by smaller Nepali entities. Document your election clearly in your accounting policies.

Step 7: Disclosures

NFRS 16 requires specific quantitative and qualitative disclosures. At a minimum, your notes must include:

• Depreciation on ROU assets (by asset class)
• Interest expense on lease liabilities
• Short-term and low-value lease expenses recognised
• Total cash outflows for leases during the period
• ROU asset carrying amounts at year-end
• Maturity analysis of lease liabilities (undiscounted)

Disclosures are the single most common deficiency found during NFRS 16 audits in Nepal. Ticking the recognition and measurement boxes is not enough.

How NFRS 16 Changes Your Financial Statements

Here’s what actually shifts when you bring a lease on-balance sheet:

If your company has bank covenants tied to debt ratios or interest coverage, review them before your first NFRS 16 adoption. This is not theoretical, it has triggered covenant renegotiations for companies in Nepal.

Five Mistakes Nepali Companies Make Under NFRS 16

1. Using only the contractual term. Ignoring renewal periods that are reasonably certain to be exercised understates the lease liability. Auditors test this directly.

2. Using an arbitrary IBR. The incremental borrowing rate must be documented and defensible. It should reflect your company’s actual credit profile and current Nepali lending rates, not a generic assumption.

3. Missing restoration obligations. If your lease requires you to return the asset in original condition, the provision belongs in the ROU asset from Day 1.

4. Misidentifying service contracts. Outsourced logistics arrangements, dedicated machinery hire, and some IT contracts contain embedded leases. Review all major contracts, not just those labelled ‘lease’.

5. Inadequate note disclosures. Many companies produce boilerplate disclosures that don’t meet the quantitative requirements of NFRS 16. The maturity analysis alone is a common gap.

For ICAN Advisory Level Students (AFR)

NFRS 16 appears consistently in the Advisory Level Financial Reporting paper. You need to handle all of the following under exam conditions:

• Identify whether a contract contains a lease (with reasons)
• Calculate the lease liability and ROU asset from the given data
• Prepare a lease amortisation schedule
• Write Year 1 journal entries
• Draft a short disclosure note

The worked example in this article is exam-representative. Work through it until you can reproduce every number without looking; that level of fluency is what the AFR paper rewards.

Need Help With NFRS 16 in Your Business?

First-time NFRS 16 adoption requires a complete contract review, documented IBR assumptions, policy drafting, and revised disclosure templates. Errors found during audit are costly to correct and create reputational risk.

At Sanket & Associates, I work with Nepali companies on:

• NFRS Technical Memos: documented accounting positions, defensible to auditors and regulators
• Accounting Policy Review: NFRS 16-compliant policies tailored to your business
• NFRS Training: in-house workshops on lease accounting for finance teams
• Standard Implementation: hands-on support through your first adoption