IFRS 16 Lease Accounting: Common Pitfalls for UAE Groups

IFRS 16 came into effect for periods beginning on or after 1 January 2019, and it fundamentally changed the balance sheet for any entity with significant property, fleet, or equipment leases. For UAE and GCC groups preparing IFRS-compliant financial statements — whether for a Big Four statutory audit, a UAE bank facility, or an ADGM filing requirement — the standard continues to generate material errors years after adoption.

This is not a theoretical problem. Misstated right-of-use (ROU) assets and lease liabilities affect debt covenants, gearing ratios, EBITDA disclosure, and corporate tax computations. Here are the four areas where UAE finance teams consistently get IFRS 16 wrong, and what the correct treatment looks like.

1. Selecting the Incremental Borrowing Rate

When the rate implicit in a lease cannot be determined — which is most of the time for property and equipment leases — lessees must use the incremental borrowing rate (IBR): the rate the lessee would pay to borrow funds, over a similar term and with similar security, to obtain an asset of similar value to the right-of-use asset in a similar economic environment.

What this means in practice for UAE entities: the IBR should reflect AED borrowing conditions (or USD where relevant), the entity's specific credit quality, the lease term, and the currency of the lease. A common error is applying a parent company's home-country borrowing rate — typically a US or European rate that understates the cost of UAE-based borrowing — producing a materially understated lease liability.

For most UAE commercial property leases, a reasonable starting point is the AED interest rate swap curve for the relevant tenor, adjusted upward for the entity's credit spread. This requires a quarterly or annual refresh when new leases are added, and auditors will test IBR inputs as part of their lease procedures.

TODO for ISZ team: Insert a specific example of an IBR range for Dubai commercial property (5-year term) versus Abu Dhabi free zone industrial lease at a particular audit date — based on an actual client engagement if possible.

2. Extension Options and "Reasonably Certain" Assessments

IFRS 16 requires lessees to include optional extension periods in the lease term when they are "reasonably certain" to be exercised. This is a higher bar than "more likely than not" but lower than contractual commitment — and it generates the most management judgment in GCC lease accounting.

In practice, many UAE property leases have annual or biennial renewal options with RERA-registered tenancy contracts. The "reasonably certain" assessment needs to consider:

- Economic incentives to extend: fit-out costs, location importance, proximity to customers or port facilities, staff amenities - Contractual terms: penalty clauses, landlord consent requirements - Practical reality: a warehouse tenant that has invested AED 2–3 million in fit-out and racking systems is economically incentivised to stay, even if the written lease is only 12 months

Underestimating the reasonably certain period systematically understates the lease liability. Conversely, including lease terms that are not supported by business plans overstates them — both are audit findings.

3. Variable Lease Payments and In-Substance Fixed Payments

IFRS 16.38 distinguishes between truly variable payments (excluded from the measurement of the lease liability) and in-substance fixed payments (included). For UAE property leases, service charge components deserve careful analysis.

A DEWA reimbursement charged as a percentage of actual utility consumption is genuinely variable and excluded. A service charge described as "variable" in a lease agreement but that in practice has been identical every year and is non-negotiable is in-substance fixed and should be included in the lease liability.

Many UAE lessees are incorrectly treating in-substance fixed charges as variable, understating their lease liabilities. Auditors increasingly test this by requesting historical service charge invoices.

4. Disclosure Quality: Moving Beyond Boilerplate

IFRS 16.59 requires a maturity analysis of undiscounted lease liabilities and significant qualitative and quantitative disclosures. In practice, many UAE IFRS reporters produce near-identical disclosure notes across different entities and lease portfolios.

Investors and analysts expect: - A maturity analysis that reflects the actual contractual undiscounted payments, not a rounded estimate - Sensitivity analysis showing the impact of a change in the discount rate (typically +/- 0.5%) - Clear explanation of material lease modifications, renewals, or terminations during the period - Where entities have benefited from COVID-19 related rent concessions (still relevant for some entities on longer-term agreements), proper disclosure of the practical expedient applied

IFRS 16 and UAE Corporate Tax

One area that catches UAE groups off-guard is the interaction between IFRS 16 and the UAE Corporate Tax Law. Under the CT law, lease payments for operating leases (as classified under the previous IAS 17 standard) were fully deductible. Under IFRS 16, the income statement shows depreciation of the ROU asset plus interest on the lease liability — a different profile and timing. The CT regulations contain transitional adjustments for this, but the deductibility treatment needs to be confirmed with a CT advisor for material lease portfolios.

Finding IFRS-Qualified Advisors

ISZ Global connects UAE and GCC groups with IFRS-qualified audit and advisory firms across Dubai, Abu Dhabi, Sharjah, and beyond. If your IFRS 16 model is due for review — particularly if your audit firm has raised findings on IBR selection, lease term, or disclosure quality — browse our verified consultant directory for the right firm.