Lease Payments in the Cash Flow Statement
Under IFRS 16, a lessee splits each payment on a recognised lease. The principal portion reduces the lease liability and is a financing outflow. The interest portion follows the entity's IAS 7 policy for interest paid. Payments that never form part of the lease liability are operating outflows.
This article forms part of our full IFRS 16 guide.
The effect of IFRS 16 on operating cash flow
Under IAS 17, operating lease rentals were operating outflows in full. Moving the principal to financing increased net cash from operating activities, with no change in total cash flow.
Lessee Classification
| Cash flow | Classification |
|---|---|
| Principal portion of the lease liability | Financing (IFRS 16.50(a)) |
| Interest portion of the lease liability | As for interest paid under IAS 7 (IFRS 16.50(b)) |
| Short-term and low-value lease payments | Operating (IFRS 16.50(c)) |
| Variable lease payments not included in the lease liability | Operating (IFRS 16.50(c)) |
Before IFRS 18, interest paid is a policy choice between operating and financing activities. For annual periods beginning on or after 1 January 2027, IFRS 18 requires an entity without a specified main business activity to classify interest paid as financing, so the whole payment on a recognised lease becomes a financing outflow. See our article on the IFRS 18 cash flow changes.
Variable payments linked to an index or a rate are part of the lease liability, so they are split between principal and interest like any other payment. Only those based on sales or usage are operating.
Non-Cash Lease Transactions
Recognising the right-of-use asset and lease liability at commencement involves no cash, so IAS 7.43 excludes it from the statement and requires disclosure. Later modifications, reassessments and exchange differences on the liability are also non-cash.
Under the indirect method, depreciation of the right-of-use asset is added back, as is lease interest where the reconciliation starts from profit before tax. Gains or losses on terminations and modifications are reversed. Under IFRS 18, the reconciliation starts from operating profit, which excludes lease interest, so no interest add-back is needed.
IFRS 16 does not specify how to classify payments made at or before commencement. They form part of the cost of the right-of-use asset, so they are commonly presented as investing outflows, as are initial direct costs.
Practical Example
Kora Ltd leases equipment on 1 January Year 1 for three annual payments of 133,100 in arrears at 10%, and pays initial direct costs of 2,000. In Year 1 it also pays 18,000 on a short-term lease and 5,000 of variable payments based on output.
| Year | Opening | Interest (10%) | Payment | Closing |
|---|---|---|---|---|
| 1 | 331,000 | 33,100 | (133,100) | 231,000 |
| 2 | 231,000 | 23,100 | (133,100) | 121,000 |
| 3 | 121,000 | 12,100 | (133,100) | nil |
The Year 1 payment of 133,100 comprises interest of 33,100 and principal of 100,000.
| Year 1 cash flow | Interest in operating | Interest in financing (IFRS 18) |
|---|---|---|
| Operating: short-term and variable payments | (23,000) | (23,000) |
| Operating: interest paid | (33,100) | - |
| Investing: initial direct costs | (2,000) | (2,000) |
| Financing: principal paid | (100,000) | (100,000) |
| Financing: interest paid | - | (33,100) |
| Total | (158,100) | (158,100) |
Depreciation of 111,000 (333,000 over three years) is added back in the operating reconciliation. The lease liability of 331,000 recognised at commencement is disclosed as a non-cash transaction.
Reconciliation of Lease Liabilities
IAS 7.44A requires the movement in liabilities arising from financing activities to be disclosed, separating cash flows from non-cash changes. For Kora, with interest in financing:
| Lease liabilities | Amount |
|---|---|
| Opening balance | nil |
| Financing cash flows | (133,100) |
| New leases (non-cash) | 331,000 |
| Interest expense (non-cash) | 33,100 |
| Closing balance | 231,000 |
IFRS 16.53(g) separately requires the total cash outflow for leases, regardless of classification. For Kora it is 156,100: 133,100 + 18,000 + 5,000. The initial direct costs are not a lease payment. See our guide to IFRS 16 disclosures.
Lessor Cash Flows
IFRS 16 does not specify lessor classification, so IAS 7 applies. Under a finance lease, the initial recognition of the net investment is non-cash. Where leasing is not a main business activity, principal received is investing and interest received follows the IAS 7 policy (investing under IFRS 18). A manufacturer or dealer lessor or a leasing company presents receipts in operating activities.
Under an operating lease, rental receipts are operating and the purchase of the leased asset is investing. See lessor accounting under IFRS 16.
In a sale and leaseback that is not a sale, the seller-lessee presents the proceeds as a financing inflow. Where it is a sale, proceeds are commonly investing, except any excess over fair value, which is financing under IFRS 16.101.
Comparison With ASC 842
ASC 842 keeps operating lease payments in operating activities in full. Finance lease principal is financing and finance lease interest is operating, because US GAAP classifies interest paid as operating. Identical leases can therefore produce different operating cash flows under the two frameworks. See IFRS 16 vs ASC 842.
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Conclusion
Lease principal is financing, lease interest follows the policy for interest paid, and payments outside the lease liability are operating. Recognition of the lease is non-cash and is disclosed in the reconciliation of liabilities arising from financing activities. From 2027, IFRS 18 moves lease interest to financing for most entities.
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