IFRS 16 outlines the measurement of lease liability as follows:

Measurement of Lease Liability

IFRS 16, paragraph 26, provides that at the commencement date, the lessee shall measure the lease liability at the present value of lease payments.

The lease payments shall be discounted using the interest rate implicit in the lease.

However, if the implicit interest rate cannot be readily determined, the incremental borrowing rate of the lessee will be used.

The interest rate implicit in the lease is the interest rate that causes the present value of the lease payments and the unguaranteed residual value to equal the fair value of the underlying asset and initial direct costs of the lessor.

The lessee’s incremental borrowing rate is the rate of interest that the lessee would have to pay to borrow funds needed to obtain a similar asset over a similar term and security.

Components of Lease Payments

The lease payments comprise the following for the right to use the underlying assets during the lease term:

• Fixed lease payments – payments made by the lessee to the lessor for the right to use the underlying asset during the lease term.
• Variable lease payments – payments made by the lessee to the lessor for the right to use the underlying asset during the lease term that vary because of the changes in facts or circumstances occurring after the commencement date other than the passage of time.
• The exercise price of a purchase option if the lessee is reasonably certain to exercise the option – the price the underlying security can be either bought or sold for.
• Amount expected to be payable by the lessee under a residual value guarantee – a guarantee made to a lessor by a party unrelated to the lessor that the value (or part of the value) of an underlying asset at the end of a lease will be at least a specified amount.
• Termination penalty if the lease term reflects the exercise of a termination option.

Lease Term

IFRS 16, Appendix A, provides that the lease term is the non-cancellable period for which a lessee has the right to use an underlying asset, together with both:

• periods covered by an option to extend the lease if the lessee is reasonably certain to exercise that option;
• periods covered by an option to terminate the lease if the lessee is reasonably certain not to exercise that option.

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