01
Banking covenants
Covenants written against gearing or against liabilities can be affected by leases arriving on the balance sheet. Where covenants predate the change, whether they were reset is a question worth asking.
Guide
Lease accounting, and who it actually applies to.
The old idea that leasing keeps assets off the balance sheet stopped being generally true. Whether it stopped being true for a particular business depends entirely on which reporting framework it uses.
MS
Matt Stiles Editor
Published 8 September 2026 Last reviewed 8 September 2026 Read time 9 min
Read this first
This is accounting, and it is separate from tax.
The accounting treatment of a lease and its tax treatment are different questions with different answers, and conflating them is the most common confusion in this area. A lease can be on the balance sheet for accounting purposes and treated one way entirely for tax, and the two do not have to agree. Everything here describes accounting presentation. Which framework a business reports under, and how any particular arrangement should be recognised within it, are questions for the accountant, and nothing on this page is a substitute for that.
The short version
Four lines on the standard.
- It removed the on and off balance sheet distinction. The old split between finance leases, which went on, and operating leases, which mostly did not, was replaced for lessees with a single model that recognises most leases.
- A right-of-use asset and a lease liability appear. The lessee recognises the right to use the asset as an asset, and the obligation to pay for it as a liability, rather than simply expensing the rentals.
- It does not reach every New Zealand business. Which framework a business reports under decides whether it applies, and a great many smaller companies are outside it.
- Tax is a separate question. Accounting presentation and tax treatment are not the same thing and do not have to agree.
What changed
One model instead of two.
Under the previous approach a lessee classified each lease as either a finance lease or an operating lease, and the classification determined the presentation. A finance lease was recognised on the balance sheet, because in substance the lessee had acquired the asset. An operating lease was not, and the rentals simply flowed through as an expense.
That distinction created a genuine and well-understood incentive. Structuring an arrangement to fall on the operating side kept a substantial obligation out of the reported position, which affected gearing, covenant headroom and how a business appeared to a lender or an investor. The obligation existed either way; it was just less visible.
NZ IFRS 16 replaced that with a single lessee model. Most leases now give rise to a right-of-use asset, representing the lessee’s right to use the underlying asset for the term, and a lease liability representing the obligation to make the payments. Short-term and low-value leases are exceptions the standard permits, and the general position is recognition.
Before
Two lessee models
After
One, for most leases
Recognised
Right-of-use asset
Against
A lease liability
The effect
What a lessee’s statements show, before and after.
Illustrative and general. How a specific arrangement is recognised depends on its terms and on the framework the entity reports under.
| Old operating lease treatment | Under NZ IFRS 16 | |
|---|---|---|
| Asset recognised | No | Yes, a right-of-use asset |
| Liability recognised | No | Yes, a lease liability |
| What appears in the income statement | A rental expense | Depreciation plus interest |
| Effect on reported assets | None | Increased |
| Effect on reported liabilities | None | Increased |
| Effect on gearing ratios | None | Generally worsened |
| Effect on the actual obligation | None | None, it was always there |
The change in presentation for a lessee. The economic obligation is unchanged in both columns.
The part that matters most
Whether it applies to a particular business at all.
New Zealand has a tiered financial reporting framework, and not every entity reports under full NZ IFRS. Many smaller companies prepare financial statements under a simpler regime, or prepare special purpose statements for their bank and Inland Revenue rather than general purpose statements at all.
For those businesses, the standard may be entirely beside the point. A discussion about right-of-use assets and lease liabilities is describing a framework they do not use, and a supplier or financier explaining what the standard means for them may simply be wrong about which framework applies.
The practical step is therefore short and worth taking. Asking the accountant which framework the business reports under settles it in one question, and the answer determines whether anything in this guide changes how the business presents a lease or whether it is background reading. Both are legitimate outcomes and only one of them requires action.
Where it bites
Four situations where the treatment has consequences.
For an entity within scope, the change is not merely presentational. These are the places it shows up in practice.
02
Borrowing capacity
A lender reading reported gearing sees a different picture than it would have. This does not change the underlying business and it can change how the business is assessed.
03
The income statement shape
A single rental expense becomes depreciation plus interest, which shifts cost between lines and changes earnings measures that exclude one or the other.
04
Comparability across periods
Statements spanning the transition are not directly comparable on some measures, which matters when a business is presenting a track record.
What it does not change
The decision about which structure to use.
It is worth being clear that this standard changed how leases are presented rather than whether leasing is a sensible way to finance an asset. The reasons to lease that have nothing to do with the balance sheet are all still there: matching a term to a replacement cycle, transferring resale risk to a financier, bundling servicing, and lowering the payment through a residual.
What has gone, for entities in scope, is one specific reason that was always somewhat artificial. A lease obligation was a real commitment before the standard and is a real commitment after it, and the change made the reported position match the economic one.
For a business outside the standard’s scope, even that has not changed. The honest position is that this is a question about presentation for some businesses and about nothing at all for others, and knowing which applies takes a single conversation.
The change, presented
What an operating lease looked like before and after, for an entity in scope.
A general illustration of the direction of the change rather than a worked set of journals. The standard itself governs recognition and measurement.
| Under the previous approach | Under NZ IFRS 16 | |
|---|---|---|
| Balance sheet, asset side | Nothing recognised | A right-of-use asset |
| Balance sheet, liability side | Nothing recognised | A lease liability |
| Income statement | A single rental expense | Depreciation plus interest |
| Expense profile across the term | Broadly even | Front-loaded, as interest falls |
| Cash flow statement | Operating | Split between financing and operating |
| Reported gearing | Unaffected by the lease | Affected by the lease liability |
Indicative of the direction of the change for entities within the standard’s scope. Not a substitute for the standard.
What recognition involves
Three things an entity in scope has to establish.
01
Whether the contract contains a lease
The standard turns on whether the arrangement conveys the right to control the use of an identified asset for a period in exchange for consideration. That is a broader question than whether the document is titled a lease, and arrangements that were never thought of as leases can fall inside it while some agreements called leases fall outside. The test is set out in the standard and it is one an accountant applies to the contract rather than to its title.
02
The lease term
Not simply the stated period. Options to extend or terminate are taken into account where their exercise is reasonably certain, which introduces judgment into a figure that looks like a fact. Two entities with identical contracts can reach different terms on defensible grounds, and the basis for the judgment is what has to be documented.
03
The discount rate
The liability is measured at the present value of the payments, so a rate is required. The standard sets out which rate is used and what is done where it cannot readily be determined. The rate chosen moves both the liability and the split between depreciation and interest, which is why it is a matter for the accountant rather than an assumption made in a spreadsheet.
Consequences
What changed for entities in scope, beyond the balance sheet.
The most visible effect was on reported gearing, because liabilities that had sat in the notes moved onto the face of the statements. For an entity with a substantial leased asset base that is a large change to a ratio that nothing about the underlying business altered, and it is the reason transition was a project rather than an adjustment.
The second effect was on the shape of the expense. A single even rental became depreciation on the right-of-use asset plus interest on the liability, and because interest is largest when the liability is largest, the combined charge is front-loaded across the term. Earnings measures that exclude depreciation and interest were affected in the opposite direction, which produced some improvements on transition that reflected presentation rather than performance.
The third effect was on covenants written before the change. Where a covenant is expressed against total liabilities or a gearing ratio, leases arriving on the balance sheet can move it without anything about the business moving. Whether covenants were reset on transition is worth confirming rather than assuming, and for a business signing new facilities the definition used in the covenant is worth reading with this in mind.
What did not change is the cash. The payments are the same payments they always were, made on the same dates, and the business’s ability to make them is unaffected by how they are presented. That is worth holding onto, because the volume of attention the standard received on transition made it easy to mistake a presentation change for a commercial one.
The other side
The financier’s accounting, which did not change in the same way.
A point that is routinely lost in the discussion is that the standard reshaped lessee accounting considerably more than lessor accounting. Financiers largely continue to distinguish between finance and operating leases in their own books, which is why the terminology survives in the market even for entities that no longer apply that distinction as lessees.
That asymmetry explains something that otherwise looks like a contradiction. A quote will describe an arrangement as an operating lease, using the term in its ordinary commercial and lessor-side sense, while the entity taking it may still recognise a right-of-use asset for it. Both statements are accurate and they are answering different questions.
The practical implication for a business is that the label on the quote is a description of the commercial arrangement rather than a statement about how it will appear in the accounts. Where the presentation matters, the question belongs with the accountant and the answer depends on the reporting framework rather than on what the document is called.
The conversation to have
Four questions that settle this for any particular business.
All four are answerable by the business’s accountant in a short conversation, and none of them can be answered from a website that cannot see the entity or its contracts.
01
Which reporting tier applies
New Zealand operates a tiered financial reporting framework, and full NZ IFRS is not what every entity reports under. This single question determines whether anything else in this guide is relevant to the business at all, and it is the one to ask first.
02
Whether existing arrangements contain leases
The standard turns on control of an identified asset rather than on the title of the document. Supply arrangements, equipment placed on site by a supplier, and service contracts with dedicated assets can all raise the question, and reviewing what the business already has is a different exercise from reviewing what it is about to sign.
03
How covenants are defined
Where facilities carry covenants expressed against total liabilities or a gearing ratio, the definitions used matter more than they did before. Whether the lender measures against the reported figure or against a defined adjusted figure is worth establishing rather than assuming.
04
What the transition looked like
For an entity that came into scope, the approach taken on transition affects comparability between years. Anyone reading the accounts, including a financier assessing an application, is looking at a series where one year was prepared differently from the one before it.
Proportion
What this is worth to a small New Zealand business.
For a contractor with two machines and a ute, the honest answer is that this may be worth very little. The standard reshaped reporting for entities that apply it, and a great many New Zealand businesses do not, which means the balance-sheet argument for or against leasing is neither an advantage nor a disadvantage to them. It is simply not a factor.
What survives regardless of framework is the commercial substance. A lease obligation is a fixed commitment that has to be serviced whether or not it appears on the face of a statement, and a financier assessing a future application will ask about it either way. The register, the bank statements and the existing commitments schedule do not depend on which accounting standard applies.
The reason to understand the change at all is that it is still used as a selling point. Where an arrangement is presented on the strength of its balance-sheet treatment, the question of which framework is being described is fair, specific and quickly answered, and it separates a real advantage from a repeated one.
The underlying numbers
What the arrangement costs, regardless of presentation.
Accounting treatment changes how a lease appears. It does not change what it costs, which is what this calculates. Indicative only, and not a quote or offer of credit.
Indicative repayment
Weekly
$477/week
$2,068 /month $19,247 total interest
$80,000
$5,000 $500,000
4 years
6 months 5 years
11.00% p.a.
8% (secured) 30% (unsecured)
Indicative only. Not a quote or offer of credit. Actual rates, fees, and repayments depend on the business profile and the lender's decision.
Sending to Prospa
Your $80,000 scenario
4 years at 11.00% . Prospa will ask a few quick questions, then provide a firm quote and funding if eligible.
Redirecting…
Method
How this guide was written, and its limits.
This describes the standard in general terms and deliberately avoids reproducing its recognition criteria, measurement requirements or exemption thresholds. Those are technical, they are set out precisely in the standard itself, and paraphrasing them on a website risks stating a requirement inaccurately in a context where accuracy is the whole point. The External Reporting Board publishes the standard and it is linked below.
Nothing here is accounting advice. Whether a particular business is within scope, and how a particular arrangement should be recognised if it is, are questions for a chartered accountant with the contract and the reporting framework in front of them.
References
Sources
- External Reporting Board, accounting standards
The publisher of NZ IFRS 16 and of the tiered reporting framework that determines which entities apply it.
- External Reporting Board, for-profit standards
The framework tiers referred to in the section on which businesses are in scope.
- Chartered Accountants Australia and New Zealand
Referenced for the point that scope and recognition are questions for a chartered accountant.
- Inland Revenue, business income tax
Backs the note that tax treatment is a separate question from accounting presentation.
- Companies Office
Context for the financial reporting obligations attaching to different kinds of New Zealand entity.
FAQ
Questions, answered
What did NZ IFRS 16 change?
It replaced the previous two-model approach for lessees, where finance leases went on the balance sheet and operating leases largely did not, with a single model recognising most leases as a right-of-use asset and a corresponding lease liability. Short-term and low-value leases are exceptions the standard permits.
Does it apply to my business?
It depends on which financial reporting framework the business uses. New Zealand has a tiered system and many smaller companies do not report under full NZ IFRS, so the standard may be entirely beside the point for them. Asking the accountant which framework applies settles it in one question.
Does leasing still keep assets off the balance sheet?
For entities reporting under the standard, generally no. For businesses outside its scope the position may be unchanged. Anyone presenting off-balance-sheet treatment as a reason to lease should be able to say which framework they are describing, because the answer differs by entity.
Is this the same as the tax treatment?
No, and conflating them is the most common confusion here. Accounting presentation and tax treatment are separate questions with separate answers and they do not have to agree. A lease recognised on the balance sheet may still be treated quite differently for tax.
What is a right-of-use asset?
The lessee’s right to use the underlying asset for the lease term, recognised as an asset in its own right. It is not the asset itself, which the lessor still owns; it is the value of being entitled to use it, carried against the obligation to pay for that entitlement.
How does the income statement change?
Where a single rental expense appeared before, depreciation on the right-of-use asset plus interest on the lease liability appear instead. That shifts cost between lines and affects earnings measures that exclude depreciation or interest, which is why some reported metrics changed on transition without anything about the business changing.
Can it affect banking covenants?
For entities in scope, yes. Covenants written against gearing or total liabilities can be affected by leases arriving on the balance sheet. Where covenants predate the change, whether they were reset on transition is worth confirming rather than assuming.
Does this change whether leasing is a good idea?
Not really. The reasons to lease that have nothing to do with presentation are all unaffected: matching a term to a replacement cycle, transferring resale risk, bundling servicing, and lowering the payment through a residual. What went is one reason that was always somewhat artificial.
Are short-term leases exempt?
The standard permits exemptions for short-term and low-value leases, with the criteria set out precisely in the standard itself. Whether a particular arrangement qualifies is a technical question, and it is one an accountant should answer with the contract in front of them rather than one to assume from a summary.
Where can I read the standard itself?
The External Reporting Board publishes New Zealand accounting standards and is linked in the sources. That is the authoritative text, and it is the right place to go for the recognition criteria, measurement requirements and exemptions this guide deliberately does not paraphrase.
Related
Keep reading
Operating lease
The structure most affected by the change in presentation.
Read onFinance lease
What was already recognised before the standard changed.
Read onGST and depreciation
The tax question, which is separate from this one.
Read onHire purchase against finance lease
The comparison, where presentation is one factor among several.
Read onAll eight structures
Every arrangement compared in the same shape.
Read on