How do lease accounting standards (IFRS 16 / ASC 842) affect a company's balance sheet and the P&L in a model?

• A. Leases create right-of-use assets and lease liabilities on the balance sheet; depreciation on the ROU asset and interest on the lease liability affect the P&L; cash flows reflect principal and interest payments.
• B. Leases do not affect the balance sheet
• C. Leases only affect cash flow as rent payments
• D. Leases remove all related assets from books

Answer: (A)

Leases are recognized on the balance sheet for lessees, creating a right-of-use asset and a lease liability. Over time, the right-of-use asset is depreciated and the lease liability accrues interest, so the P&L shows depreciation expense and interest expense rather than a single rent expense. The cash flow impact comes from the lease payments themselves, with the portion that reduces the liability treated as a principal payment (financing effect) and the interest portion shown as interest; total cash outflows reflect the lease payments. This combination explains why the asset base grows and then gradually declines as depreciation and payments occur, while the P&L includes depreciation and interest rather than just rent.