Multiple choice
Accounting · 5 min read
IFRS 16 leases explained for UK interviews
Since 2019, UK and European companies report almost all leases on the balance sheet under IFRS 16. US companies under US GAAP don't, for most leases. That difference catches out candidates comparing companies across the Atlantic.
What IFRS 16 does
- On day one, the company records a lease liability (the present value of the lease payments) and a right-of-use asset of the same amount.
- Each year, the asset is depreciated and the liability accrues interest. Rent no longer appears as an operating cost.
- Each payment reduces the liability, like repaying a loan.
Example: £10m a year for 5 years, paid at the end of each year, discounted at 5%, gives a lease liability of about £43.3m.
The effects interviewers ask about
- EBITDA goes up: the rent is replaced by depreciation and interest, both below EBITDA.
- Net debt goes up: the lease liability is debt-like.
- Leverage (net debt ÷ EBITDA) usually rises, because the liability is several times the rent added back.
- Operating cash flow looks higher: the principal repayment moves to financing cash flow.
Keeping valuations consistent
If you use IFRS 16 EBITDA, include lease liabilities in enterprise value. If you use EBITDA after rent (as US GAAP operating leases show it), leave them out. Mixing the two makes UK companies look cheaper or more expensive than they are.
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