When IFRS 16 came into effect, most of the conversation focused on how accountants would calculate lease liabilities and right of use assets. Less attention went to how the people reading those financial statements afterward, particularly lenders and credit analysts, would actually interpret the new numbers. That gap matters, because the way credit professionals read your statements can directly affect your borrowing costs, covenant compliance, and overall credit standing.
Why Lenders Care So Much About Lease Accounting
Before IFRS 16, many operating leases stayed off the balance sheet entirely, which meant a company’s reported debt levels often looked lighter than its actual financial commitments. Lenders who understood this often made their own manual adjustments to account for off balance sheet leases when assessing credit risk.
IFRS 16 changed this by bringing most leases onto the balance sheet as a liability. On the surface, this should have made lenders’ jobs easier, since the information they used to estimate manually is now presented directly in the financial statements. In practice, it changed the conversation in a different way.
The Debt Metrics That Shift
When lease liabilities move onto the balance sheet, several commonly used credit metrics shift as a result. Total reported debt increases, since lease liabilities are now included. This affects the debt to equity ratio, which can look worse than it did under the previous accounting treatment, even though the business’s actual obligations have not changed.
EBITDA is also affected, since lease expense that was previously recorded as a single operating cost is now split into depreciation and interest, both of which are typically added back in EBITDA calculations. This means EBITDA figures reported under IFRS 16 can appear higher than they would have under the old standard, even without any real change in underlying performance.
Why This Creates Confusion in Covenant Calculations
Many loan agreements include financial covenants based on metrics like debt to EBITDA or interest coverage ratios. If those covenants were written based on pre-IFRS 16 definitions, the mechanical changes introduced by the new standard can cause a business to appear closer to breaching a covenant, or further from breaching one, without any actual change in financial health.
This is why many lenders and borrowers renegotiated covenant definitions around the time IFRS 16 was adopted, specifically to exclude the impact of the new lease accounting treatment and preserve the original intent of the covenant.
What Experienced Credit Analysts Actually Look For
Credit analysts who understand IFRS 16 well tend to look past the headline numbers and dig into the disclosures to understand the real nature of a company’s lease obligations. Some of the key things they typically examine include:
- The maturity analysis of lease liabilities, to understand how lease payment obligations are spread out over future periods and assess liquidity risk.
- The split between lease interest expense and lease depreciation, to better estimate a company’s true cash interest burden.
- Disclosures about short term and low value lease exemptions, since these represent lease costs still being expensed rather than capitalized.
- Variable lease payment disclosures, to identify obligations that are not captured in the reported lease liability but still represent a real ongoing cost.
- Judgments disclosed around lease term assumptions, particularly around renewal options, since overly optimistic assumptions can understate future obligations.
Adjusting for Comparability Across Companies
One challenge lenders face is comparing companies that adopted IFRS 16 differently, or that operate in industries with very different leasing intensity. A retailer with hundreds of store leases will show a very different balance sheet impact than a company with few physical locations, even if their underlying businesses are similarly sized.
Experienced analysts often normalize lease related metrics across companies to make fairer comparisons, sometimes by adding back lease related depreciation and interest to approximate a pre-IFRS 16 view, particularly when comparing against companies still reporting under standards that treat leases differently.
Why Clear Disclosures Work in Your Favor
Businesses that provide clear, detailed lease disclosures tend to have an easier time with lenders and analysts, simply because it reduces the guesswork involved in assessing credit risk. Vague or minimal disclosures can lead analysts to apply more conservative assumptions when they cannot get clarity on lease terms, renewal likelihood, or variable payment exposure.
This is one of the practical reasons strong IFRS 16 disclosure practices matter beyond pure compliance. They can genuinely influence how a lender perceives your creditworthiness.
Practical Takeaways for Finance Teams
If your business relies on debt financing, it is worth reviewing your loan covenants to confirm whether they were updated to reflect IFRS 16’s impact, and proactively communicating any significant lease related changes to lenders before they show up unexpectedly in reported figures. Building strong, transparent lease disclosures also helps credit analysts assess your business accurately, rather than defaulting to conservative assumptions due to a lack of clarity.
FAQs
1. Why did EBITDA figures often increase after companies adopted IFRS 16?
Lease expense that was previously recorded as a single operating cost is now split into depreciation and interest, both of which are commonly added back when calculating EBITDA, which can make EBITDA appear higher than under previous lease accounting.
2. Do loan covenants automatically account for the impact of IFRS 16?
Not necessarily. Many covenants were written before IFRS 16 and needed to be renegotiated or clarified to exclude the mechanical impact of the new lease accounting treatment on debt and EBITDA calculations.
3. What do credit analysts focus on beyond the headline lease liability figure?
Experienced analysts typically review the maturity analysis of lease liabilities, the split between interest and depreciation, variable payment disclosures, and judgments around lease term assumptions to get a fuller picture of a company’s real obligations.
Final Thoughts
IFRS 16 did not just change how leases are recorded. It changed how lenders and credit analysts need to read financial statements to get an accurate picture of a company’s financial position. Businesses that understand this shift, and communicate proactively with their lenders about it, are in a much stronger position than those that assume the accounting change is purely an internal finance matter.
