We Are Renting Out a Simple Office… But the Accounting Isn’t So Simple
We Are Renting Out a Simple Office… But the Accounting Isn’t So Simple
Our organisation just signed a 5-year lease agreement for office space. The deal looks straightforward: pay $2,500 per month, which includes $500 operating costs (like cleaning and maintenance). But under IPSAS 43 / IFRS 16 Leases, accounting is far from simple.
Why a Lease Is More Than Rent
Modern accounting standards say: when you commit to a lease longer than 12 months, you’re not just renting — you’re essentially borrowing the right to use an asset. That means we must recognise:
- A Right-of-Use (ROU) Asset — representing our right to use the office space.
- A Lease Liability — representing our obligation to make lease payments.
Only the pure rental portion ($2,000) is part of this calculation. The $500 monthly operating cost is treated as an expense in the period incurred.
Step 1: Separate Lease and Service Components
- Lease component: $2,000/month
- Service (operating costs): $500/month
Total monthly cash outflow remains $2,500, but only $2,000 is used to calculate the ROU asset and liability.
Step 2: Measure the Lease Liability
We commit to $2,000 × 60 months = $120,000 lease payments.
Now we discount those payments at our incremental borrowing rate (say 10% annually, or 0.833% monthly).
Using the Present Value of an Annuity formula:
So, the initial lease liability = $90,650.
Step 3: Recognise the Right-of-Use Asset
At commencement, the ROU asset equals the lease liability (plus any initial direct costs).
- Dr Right-of-Use Asset $90,650
- Cr Lease Liability $90,650
Operating costs of $500/month will be expensed directly:
- Dr Expense (Operating Costs) $500
- Cr Cash $500
Step 4: Account Over Time
Every month, we:
- Recognise interest expense on the lease liability (using the effective interest method).
- Reduce the lease liability with the cash paid ($2,000 portion).
- Depreciate the ROU asset over 5 years.
Mini Lease Schedule (first 2 months + last month)
| Month | Opening Liability | Interest (0.833%) | Cash Paid (Lease) | Closing Liability |
| 1 | 90,650 | 755 | 2,000 | 89,405 |
| 2 | 89,405 | 745 | 2,000 | 88,150 |
| 60 | 1,983 | 17 | 2,000 | ~0 |
Meanwhile, the ROU asset of $90,650 is depreciated on a straight-line basis:
Monthly Journal Entries (simplified)
- Lease payments:
- Dr Interest Expense (e.g. $755 in Month 1)
- Dr Lease Liability (balance of payment)
- Cr Cash $2,000
- Operating costs:
- Dr Expense $500
- Cr Cash $500
- Depreciation:
- Dr Depreciation Expense $1,511
- Cr Accumulated Depreciation $1,511
Wrap-Up
Even when the contract seems simple — just $2,500 a month — IPSAS/IFRS accounting makes us peel it apart. By recognizing a lease liability, a right-of-use asset, and separating service costs, we present a transparent picture of the real financial commitment.
