Lease accounting is one of the areas where the gap between business understanding and accounting treatment becomes most visible. While lease arrangements are operational in nature, their accounting impact is structural, long-term, and material to financial statements.
For growing businesses and multinational groups, lease accounting is not merely a compliance topic. It directly affects leverage ratios, EBITDA, return metrics, and stakeholder perception.
The shift from expense-based to balance-sheet-based thinking
Under modern accounting frameworks, including Ind AS 116 and IFRS 16, the focus of lease accounting moved decisively from legal form to economic substance.
If a contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration, it creates a right-of-use asset and a corresponding lease liability.
This treatment applies irrespective of whether the arrangement is described as rent, lease, hire, or service, provided control criteria are met.
For many businesses, this results in a fundamental change in how lease commitments appear in the financial statements, even though the underlying cash flows remain unchanged.
Balance sheet recognition changes financial optics
Capitalisation of leases increases reported assets and liabilities. This has downstream effects on key financial metrics.
Leverage ratios increase due to recognition of lease liabilities. EBITDA typically improves as lease expenses are replaced by depreciation and interest. Asset turnover and return ratios change due to the enlarged balance sheet.
For groups reporting to global headquarters, private equity sponsors, or lenders, these changes often require careful explanation to ensure comparability and understanding.
Lease accounting therefore becomes a communication issue as much as an accounting one.
Identification of a lease requires careful contract analysis
One of the most common technical gaps arises during lease identification.
Contracts often bundle asset usage with services. Examples include office leases with facility management, data centre arrangements, logistics contracts, and equipment arrangements with maintenance components.
Determining whether an identified asset exists, whether substitution rights are substantive, and whether control is transferred requires careful reading of contractual terms, not assumptions.
Failure at this stage leads to incorrect classification and inconsistent accounting across periods.
Lease term determination is a judgement-heavy area
Lease term determination is not always straightforward.
Options to extend or terminate must be evaluated based on economic incentives, not management intent alone. Factors such as fit-out investments, relocation costs, strategic importance of the location, and historical behaviour influence the assessment.
Overly conservative or aggressive assumptions can materially impact recognised lease liabilities and right-of-use assets.
Inconsistent application of lease term judgement is a frequent point of audit challenge, especially in multi-location or multinational environments.
Measurement is mechanical, judgement is not
While lease measurement involves present value calculations, the inputs driving those calculations are judgement-based.
Determination of incremental borrowing rate, treatment of variable lease payments, reassessment triggers, and modification accounting all require consistent policy frameworks.
Many businesses rely heavily on spreadsheets or lease tools without fully understanding the accounting logic embedded within them. This creates dependency risk and weakens review controls.
Strong lease accounting requires both technical understanding and governance, not just tools.
Why lease accounting issues surface late
Lease accounting issues rarely emerge during routine operations. They typically surface during audits, group reporting reviews, carve-outs, or due diligence.
At that point, correcting errors becomes complex. Comparative periods may need restatement. Group consolidation adjustments increase. Explanations become harder to align across stakeholders.
The cost of late correction is significantly higher than the cost of early discipline.
Lease accounting maturity becomes critical at scale
As organisations scale, lease portfolios become larger and more diverse. Multiple geographies. Different currencies. Local practices. Varying contract structures.
Without a centralised lease accounting framework, inconsistencies creep in silently. These inconsistencies often remain unnoticed until external scrutiny increases.
For multinational groups, lease accounting maturity is often viewed as an indicator of overall financial control maturity.
The objective is faithful representation, not complexity
Effective lease accounting is not about overengineering models or documentation.
It is about faithful representation of obligations, consistent judgement, and transparent disclosure. When done correctly, lease accounting becomes predictable and defensible.
It reduces audit friction, improves stakeholder confidence, and strengthens financial reporting credibility.
Final thought
Lease accounting sits at the intersection of contracts, judgement, and financial reporting.
For growing businesses and multinational organisations, treating it as a routine accounting task is a mistake. It deserves structured analysis, experienced oversight, and periodic reassessment.
When lease accounting is handled with technical rigour, it stops being a recurring pain point and becomes a quiet strength in the financial reporting framework.
And in complex organisations, quiet strengths matter the most.
