IFRS 16 lifts EBITDA by reclassifying lease costs from operating expenses to depreciation and interest. For analysts and lenders, adjustments are essential to ensure comparability, covenant assessment, and sound financial decision-making.
This article gives you a clear answer to a common question: why does IFRS 16 increase EBITDA? We’ll walk through the mechanics behind the uplift, show how to normalize results for better comparability, and explain why the standard matters for covenants, leverage ratios, and investor communication.
Under IFRS 16, leases are recognized on the balance sheet with a right-of-use asset and a lease liability. The asset is depreciated and interest expense is recognized on the liability. Under direct expensing, leases are simply recorded as lease expenses in the income statement on a straight-line basis. This change alters how lease costs are reflected in the accounts and directly impacts key performance metrics such as EBITDA.
For CFOs, analysts, and investors, it is essential to understand that this is an accounting-driven uplift, not an improvement in economic profitability or free cash flow.
Under the old model, operating lease commitments were recognized as opex and deducted directly from operating profit. Every payment reduced EBIT and EBITDA in a straightforward way.
IFRS 16 fundamentally changes this treatment. Most leases with a term longer than 12 months must be capitalized. On the balance sheet, a right-of-use asset is recognized, matched by a corresponding lease liability.
On the income statement, rent expense is removed from operating costs. Instead, two new lines appear: depreciation of the right-of-use asset and interest expense on the lease liability.
Here’s the critical point: because EBITDA is defined as earnings before interest, tax, depreciation, and amortization, both the depreciation and the interest are excluded. The lease expense no longer reduces EBITDA at the operating level. The result is an optical uplift in EBITDA.
But the company is not generating more cash, nor has its enterprise value changed. It is simply a matter of presentation. That is why sell-side analysts, credit rating agencies, and investors adjust reported numbers to strip out the IFRS 16 effect and maintain comparability.
|
Item |
Before IFRS 16 (Operating Lease) |
After IFRS 16 (Capitalized Lease) |
|
Income Statement |
Lease expense in operating costs |
Depreciation + interest below EBITDA |
|
EBITDA |
Reduced by lease expense |
Higher (lease expense excluded from EBITDA) |
|
Balance Sheet |
NA |
Right-of-use asset + lease liability |
|
Cash Flow Statement |
Lease in operating cash flow |
Interest in financing, principal repayment in financing |
|
Leverage Ratios |
Lower (leases excluded) |
Higher (lease liability treated as debt) |
This table illustrates why reported EBITDA increases, while reported net debt also rises.
So how do you compare performance pre- and post-IFRS 16? The solution is to normalize EBITDA by reversing the uplift:
Adjusted EBITDA = Reported EBITDA – (lease depreciation + lease interest) + lease costs
The figures are typically available in the disclosures to the financial statements, and many CFOs proactively disclose them. This reconciliation ensures like-for-like comparability across reporting periods and peer groups.
Two contrasting cases show the importance:
Without adjustment, margin analysis, EV/EBITDA multiples, and peer comparisons risk becoming distorted. With adjustment, analysts get a true measure of operating performance.
A best practice is to integrate a standardized bridge in your financial models. Drop in IFRS 16 depreciation and interest, add back lease payments, and you maintain consistency in valuation work, peer benchmarking, and trend analysis.
And it is not just equity analysts who care. Private equity funds, credit analysts, rating agencies, and corporate development teams all rely on adjusted EBITDA to assess credit metrics, leverage, and acquisition targets.
Airlines provide a striking illustration. Aircraft leases are long-term, high-value commitments. When IFRS 16 took effect, reported EBITDA for major carriers rose sharply – in some cases by billions. Yet no investor believed airlines had suddenly become more profitable overnight.
Adjustments were essential to evaluate unit economics, EBITDAR margins, and return on invested capital. This industry case underlines why normalized figures are critical whenever lease exposure is material.
For finance teams, the impact goes beyond accounting optics. IFRS 16 can directly affect compliance with debt covenants and the way lenders perceive leverage.
EBITDA is one of the most common covenant metrics. When reported EBITDA rises, net leverage ratios appear stronger, and covenant headroom looks larger. But lenders are not misled: lease liabilities represent real contractual obligations.
That is why many banks refine their definitions. Common approaches include:
If you do not adjust, you risk misinterpretation. Imagine EBITDA rises 20% under IFRS 16. On paper, leverage improves. But if the bank strips out the uplift and adds lease liabilities as debt, you may be closer to breaching covenants than expected.
The solution is proactive transparency. CFOs and FP&A teams should reconcile reported and adjusted metrics in covenant reporting packs. This avoids disputes, builds trust with lenders, and ensures alignment with rating agencies.
And remember: IFRS 16 also increases reported gross debt on the balance sheet, impacting solvency ratios, gearing, and even credit ratings.