How are lease incentives accounted for under IFRS 16 and what impact do they have on the right-of-use asset?

Question

AcadiFi · Accepted Answer

Under IFRS 16, lease incentives received by the lessee reduce the initial measurement of the right-of-use (ROU) asset. They do NOT create a separate deferred income line or get amortized independently.

**Worked Example -- Halcyon Retail Group (fictional)**

Halcyon signs a 10-year retail lease with annual payments of $120,000. The landlord provides a $200,000 tenant improvement allowance (TIA) as an incentive. The discount rate is 5%.

| Component | Amount |
|---|---|
| PV of lease payments (10 × $120K at 5%) | $926,400 |
| Less: Tenant improvement allowance | ($200,000) |
| **Initial ROU Asset** | **$726,400** |

The lease liability is still $926,400 because Halcyon owes the full stream of payments. The incentive only reduces the ROU asset, which is then depreciated over the lease term.

Annual ROU depreciation = $726,400 / 10 = $72,640

\`\`\`mermaid
flowchart LR
    A[Lease Signed] --> B[Calculate PV of Lease Payments]
    B --> C[Lease Liability = PV of Payments]
    A --> D[Identify Lease Incentives]
    D --> E[Reduce ROU Asset by Incentive Amount]
    B --> E
    E --> F[Depreciate Reduced ROU Over Lease Term]
    C --> G[Unwind Liability Using Effective Interest]
\`\`\`

The key exam implication is that lease incentives cause the ROU asset to be lower than the lease liability from day one. This means total lease expense (depreciation + interest) starts higher than the straight-line rent that an operating lease would have shown under the old IAS 17 standard, front-loading expense recognition.

How are lease incentives accounted for under IFRS 16 and what impact do they have on the right-of-use asset?

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