If you work in finance or accounting, you have probably heard a lot about IFRS 16. This lease accounting standard changed the way companies report their leases, and it has a real effect on financial statements. One of the biggest changes shows up in EBITDA. But that is not the only number affected. Ratios like debt-to-equity, return on assets, and interest coverage also shift once IFRS 16 comes into play.
In this article, we will break down what IFRS 16 is, why it changed EBITDA, and how it affects other key ratios that investors, lenders, and managers rely on.
What Is IFRS 16?
IFRS 16 is an accounting standard for leases. It was introduced by the International Accounting Standards Board (IASB) and became effective for annual reporting periods starting on or after January 1, 2019.
Before IFRS 16, companies split their leases into two types:
- Operating leases – kept off the balance sheet, with lease payments simply recorded as an expense.
- Finance leases – recorded on the balance sheet as an asset and a liability.
IFRS 16 removed this split for lessees. Now, almost all leases must be recorded on the balance sheet. A company recognizes a right-of-use (ROU) asset and a matching lease liability, no matter if the lease was previously called operating or finance.
This single change is the reason so many financial ratios moved.
Why EBITDA Changes Under IFRS 16
EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. It is a popular measure because it strips out non-cash and financing costs, giving a cleaner view of operating performance.
Under the old rules, operating lease payments were treated as a single operating expense. This expense reduced EBITDA directly, since it sat above the EBITDA line on the income statement.
Under IFRS 16, that single lease expense is replaced by two separate costs:
- Depreciation on the right-of-use asset
- Interest expense on the lease liability
Both of these sit below the EBITDA line. As a result, the old lease expense disappears from operating costs, and EBITDA goes up. This is not because the company is actually performing better. It is simply a reclassification of costs from operating expense to depreciation and interest.
Example: A retail company with many store leases used to report a single annual rent expense of $10 million within operating costs. Under IFRS 16, this $10 million might now appear as $7 million depreciation and $3 million interest. Neither number affects EBITDA, so EBITDA rises by roughly $10 million, even though nothing changed about how the business actually runs.
This is why analysts covering lease-heavy industries, such as retail, airlines, and hospitality, pay close attention to this shift. Comparing EBITDA before and after IFRS 16 without adjustment can be misleading.
Impact on Other Key Financial Ratios
EBITDA is just the starting point. Because IFRS 16 adds assets and liabilities to the balance sheet, several other ratios change too.
1. Debt-to-Equity Ratio
Since lease liabilities now appear on the balance sheet, total liabilities increase. Equity usually stays roughly the same in the short term. This pushes the debt-to-equity ratio higher, making the company look more leveraged than it did under the old standard, even if its actual borrowing habits have not changed.
2. Return on Assets (ROA)
Total assets increase because of the new right-of-use asset. If net income stays flat or grows only slightly, ROA (net income divided by total assets) tends to fall. A larger asset base combined with similar earnings brings the ratio down.
3. Interest Coverage Ratio
This ratio measures how easily a company can pay interest on its debt using operating earnings. Since IFRS 16 adds a new interest expense component from lease liabilities, and EBITDA or EBIT figures may be used differently depending on the formula, this ratio often shifts. Some companies see coverage appear stronger if EBITDA is used as the numerator, since EBITDA rises while interest also rises, but the balance is not always proportional.
4. Current Ratio
Lease liabilities are split between current and non-current portions, just like loans. This adds to current liabilities, which can lower the current ratio (current assets divided by current liabilities), signaling a slightly weaker short-term liquidity position on paper.
5. Asset Turnover Ratio
Asset turnover is calculated as revenue divided by total assets. With total assets now larger due to the right-of-use asset, this ratio typically declines, suggesting the company is generating less revenue per dollar of assets, even if operational efficiency has not truly changed.
Why This Matters for Businesses and Investors
These shifts are not just academic. They have practical consequences:
- Loan covenants: Many loan agreements include limits based on debt-to-equity or interest coverage ratios. IFRS 16 can accidentally push a company closer to breaching these covenants, even without any change in actual financial health.
- Valuation multiples: Since EBITDA is a common input for valuation multiples like EV/EBITDA, a higher EBITDA can make a company appear cheaper on this basis, which can mislead investors comparing companies that report under different standards or timelines.
- Performance bonuses: If management bonuses are tied to EBITDA targets, IFRS 16 could make those targets easier to hit, not because performance improved, but because of the accounting change itself.
- Comparability across companies: Comparing a company that leases most of its assets to one that owns them outright becomes trickier. The leasing company will show inflated EBITDA and assets relative to how it operated before.
How Companies Are Adapting
Many businesses now report both IFRS 16 and pre-IFRS 16 (sometimes called “frozen GAAP” or adjusted) figures in their disclosures, especially for covenant calculations agreed upon before the standard changed. Analysts often adjust EBITDA back down by adding back the old-style lease expense, to get a more consistent view across time periods and between companies.
Some lenders have also updated their loan agreements to define financial ratios based on the old lease accounting treatment, avoiding any unintended breach caused purely by the new standard.
FAQs
Q 1. Does IFRS 16 increase or decrease EBITDA?
IFRS 16 increases EBITDA. It moves the old lease expense out of operating costs and into depreciation and interest, so it no longer reduces EBITDA.
Q 2. Why do lease liabilities appear on the balance sheet now?
IFRS 16 requires almost all leases to be recorded as a right-of-use asset and a lease liability, removing the old off-balance-sheet treatment for operating leases.
Q 3. Does IFRS 16 affect a company’s actual cash flow?
No. Total cash paid for leases stays the same. IFRS 16 only changes how that cost is classified and reported, not the actual cash going out.
Q 4. Which ratios are most affected by IFRS 16?
EBITDA, debt-to-equity, return on assets, interest coverage, current ratio, and asset turnover are the ratios most affected, since they all use figures IFRS 16 changed.
Q 5. How can I compare EBITDA across companies fairly after IFRS 16?
Add back the old-style lease expense to get pre-IFRS 16 figures, or check if the company already reports adjusted EBITDA for comparison.
Final Thoughts
IFRS 16 did not change how a business actually operates. It changed how leases are recorded in financial statements. But because so many financial ratios are built from balance sheet and income statement figures, this accounting change ripples through EBITDA, leverage ratios, return ratios, and liquidity ratios.
For anyone reading financial statements, whether you are an investor, lender, or company manager, it is worth understanding this shift. A rising EBITDA or a growing balance sheet does not always mean stronger performance. Sometimes, it is just a new way of counting the same numbers.
