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Calculate a Lease Amortisation Schedule — IFRS 16 Worked Example | CALC SERIES #10

Building the lease liability amortisation table is one of the most tested IFRS 16 calculations. Here's the three-year worked example using the effective interest rate method — opening balance, interest, payment, closing balance — with every journal entry.

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Calculate a Lease Amortisation Schedule — IFRS 16 Worked Example | CALC SERIES #10

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In this video

0:00 Introduction — why EIR and not straight-line for leases
0:20 The scenario — 3-year lease, €40k/yr payments in arrears, IBR 5%
0:48 Opening lease liability — PV of three payments at 5%: €108,930
1:15 Year 1 interest: €108,930 × 5% = €5,447 · closing balance €74,377
1:55 Year 2 interest: €74,377 × 5% = €3,719 · closing balance €38,096
2:30 Year 3 interest: €38,096 × 5% = €1,905 · closing balance ≈ €0
3:00 Full table including interest and payments for all three years
3:30 Journal entries — Year 1 interest accrual and cash payment
4:00 Common mistake — straight-line interest across the lease term
4:30 Recap — EIR amortisation sequence

Key terms in plain English

Incremental borrowing rate (IBR): The rate the lessee would have to pay to borrow funds to obtain an asset of similar value in a similar economic environment over a similar term. Under IFRS 16, the IBR is used when the interest rate implicit in the lease cannot be readily determined.
Effective interest method: A method of allocating interest income or expense over the relevant period so that the rate in each period is constant relative to the carrying amount of the financial liability. Applied to the lease liability, it produces a higher interest charge in the early years and a lower charge as the liability reduces.
Lease liability: The present value of lease payments not yet made, measured at the commencement date using the interest rate implicit in the lease or the IBR. It is subsequently adjusted for interest accrual, payments made, and lease modifications.
Arrears payment: A payment made at the end of the period rather than the beginning. For an annuity in arrears, each payment is discounted by one more period than for an annuity in advance.

Full explanation

Why the effective interest method applies to lease liabilities

IFRS 16 requires the lease liability to be measured using the effective interest rate method, following the same principles as IFRS 9 for financial liabilities. The underlying logic is that the lease liability is a form of debt — the lessee owes payments in exchange for the right to use the asset. The interest on that debt should reflect the outstanding balance, not a flat annual amount.

Under straight-line interest, the charge would be the same each year. Under the effective interest method, the charge decreases each year as the liability reduces — because interest is calculated on the remaining balance, not the original balance.

The scenario: three-year lease, €40,000 annual payments in arrears, IBR 5%

At commencement, the lessee calculates the opening lease liability as the present value of three payments of €40,000 in arrears at 5%. PV = €40,000 / 1.05 + €40,000 / 1.05² + €40,000 / 1.05³ = €38,095 + €36,281 + €34,554 = €108,930.

Year 1 — interest, payment, closing balance

Opening balance: €108,930. Interest at 5%: €108,930 × 5% = €5,447. Payment at end of year: €40,000. Closing balance: €108,930 + €5,447 − €40,000 = €74,377. Journal entry at payment: Dr Finance cost €5,447 / Dr Lease liability €34,553 / Cr Cash €40,000.

Year 2 — smaller interest on reduced balance

Opening balance: €74,377. Interest at 5%: €74,377 × 5% = €3,719. Payment: €40,000. Closing balance: €74,377 + €3,719 − €40,000 = €38,096.

Year 3 — final balance returns to zero

Opening balance: €38,096. Interest at 5%: €38,096 × 5% = €1,905. Payment: €40,000. Closing balance: €38,096 + €1,905 − €40,000 = €1 rounding difference, effectively zero. Total interest over three years: €5,447 + €3,719 + €1,905 = €11,071. This is the total finance cost recognised in P&L over the lease term.

Journal entries for Year 1

At commencement: Dr Right-of-use asset €108,930 / Cr Lease liability €108,930.

Interest accrual during Year 1: Dr Finance cost €5,447 / Cr Lease liability €5,447.

Annual payment at year end: Dr Lease liability €40,000 / Cr Cash €40,000.

Depreciation of ROU asset (assuming straight-line over 3 years): Dr Depreciation €36,310 / Cr Accumulated depreciation €36,310.

Common mistake: straight-line interest

Dividing the total interest of €11,071 equally across three years gives €3,690 per year. This understates the Year 1 interest by €1,757 (€5,447 minus €3,690) and overstates Years 2 and 3. The lease liability closing balance at the end of Year 1 would also be wrong — €74,690 rather than the correct €74,377. Over the lease term, the same total interest is recognised, but the distribution between years is wrong, affecting reported finance costs, profit, and the liability balance each period.