Leasing Under US GAAP and IFRS: Similar New Standards with Significant Differences
Leasing is a prevalent practice for entities in a wide variety of industries. Stakeholders have expressed concerns about the existing lease accounting guidance in both Topic 840, Leases, and International Accounting Standard (IAS) 17, Leases, because it does not require lessees to recognize assets and liabilities from operating leases on the balance sheet. Stakeholders have criticized that this model fails to meet the requirements of financial statement users because it does not faithfully represent leasing transactions.
As a result of these concerns, the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) began a joint project in 2006 intended to comprehensively restructure the existing lease accounting guidance for both lessees and lessors.
In January 2016, the IASB issued its final standard, IFRS 16, Leases, which supersedes the guidance in IAS 17. In February 2016, the FASB issued Accounting Standards Update (ASU) No. 2016-02, Leases (Topic 842). This ASU supersedes the guidance in Topic 840 and introduces a new Topic 842, Leases.
Because the FASB and the IASB worked jointly on the leases project, many of the requirements in the two standards align, such as requiring lease assets and lease liabilities to be recorded on the balance sheet and requiring key disclosures about these arrangements. There are, however, significant differences.
One of the most significant differences between the two standards relates to the classification of a lease. Under US GAAP, a lessee must determine whether a lease is an operating or a finance lease. Both types of leases require a lessee to record a right-of-use asset and a lease liability on the balance sheet, but the income statement presentation is different between the two classifications.
Under an operating lease, a single lease cost, generally allocated on a straight-line basis over the lease term, is presented in the income statement. Under a finance lease, interest on the lease liability is recognized separately from the amortization of the right-of-use asset in the income statement. The lease expense is typically higher in the earlier years of the lease term. IFRS does not distinguish lease classifications for a lessee. All leases are accounted for similar to a finance lease under US GAAP.
Lessor accounting is also slightly different between the two bases of accounting. A lessor has three categories to determine classification under US GAAP: an operating, a direct financing, or a sales-type lease. If a lessor has a direct financing lease, the selling profit is deferred at the commencement date and included in the measurement of the net investment on the lease. A lessor only has two categories to classify a lease under IFRS: an operating or a finance lease. Selling profit may be recognized at the lease commencement for all finance leases.
The two standards also differ in the definition of a lease. Under US GAAP, the definition of a lease is specific to identified property, plant, or equipment. Under IFRS, a lease can be any asset and the definition of a lease is not restricted to just property, plant, or equipment. IFRS 16 further notes that a lessee may, but is not required to, apply the leasing guidance to leases of intangible assets other than those under licensing arrangements. This is not permitted under ASU No. 2016-02.
IFRS also includes a threshold exemption for leases of low-value assets, such as tablets and personal computers, small items of office furniture, and telephones. This exemption allows a lessee not to recognize these leases on its balance sheet. The IASB noted low-value assets referred to assets less than $5,000 during its deliberations. No such exemption exists under US GAAP; however, the concept of materiality applies to the financial statements as a whole. Accordingly, an entity may adopt a capitalization policy that it will not recognize lease assets that it determines to be immaterial – either individually or in the aggregate. The IFRS exemption does not require lessees to aggregate leases less than $5,000 for materiality considerations.
Another key difference between the two standards relates to the classification of a sublease. ASU No. 2016-02 requires an initial lessee that subleases the underlying asset, therefore becoming a sublessor, to determine the classification of the sublease by referencing the leased asset in the original lease. IFRS 16 requires that the sublessor determine the sublease classification by referencing the right-of-use asset that arose from the original lease.
Some lease arrangements contain variable lease payments dependent upon an index or a rate, such as the Consumer Price Index or the London Interbank Offered Rate. Entities are required to measure these variable lease payments initially at the index or rate on the lease commencement date. The remeasurement of these payments, however, differs under the two bases of accounting. Under US GAAP, an entity remeasures the payments only when it is required to reassess the lease obligation for other purposes. IFRS, however, requires an entity to remeasure these payments every time an adjustment to the lease payments takes effect.
ASU No. 2016-02 and IFRS 16 also contain several other important differences, including:
Short-term lease exemption. Both standards permit a lessee to apply a short-term lease exemption for a lease with a term of 12 months or less. In determining the lease term, a lessee excludes purchase options that it is reasonably certain to exercise under US GAAP. A lessee excludes all purchase options from this determination under IFRS.
Asset measurement. A lessee measures its right-of-use asset at the present value of lease payments under US GAAP. Under IFRS, a lessee typically measures its right-of-use asset by using a cost model. There are measurement alternatives to which the asset may be subject as well.
Sale and leaseback transactions. A sale and leaseback transaction is not a sale under US GAAP if it does not satisfy the sale requirements in Topic 606, Revenue from Contracts with Customers. If the transaction is a sale, the seller-lessee can recognize the entire gain on the transaction.
Under IFRS, a sale and leaseback transaction is not a sale if it does not meet the requirements for determining when a performance obligation is satisfied in IFRS 15, Revenue from Contracts with Customers (similar to Topic 606 under US GAAP). If the transaction is a sale, the seller-lessee can only recognize a gain for the amount that relates to the buyer-lessor’s residual interest in the leased asset at the end of the leaseback.
In summary, the main differences between Topic 842 and IFRS 16 primarily relate to the lessee accounting model. It is important to note that although the standards have similar requirements, some leases will be accounted for differently between the two bases of accounting.
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Mandi Polick, CPA, is the managing editor of the GAAP Reporter product with Thomson Reuters Checkpoint with the Tax & Accounting business of Thomson Reuters. She is a CPA in both the state of New York and the state of Iowa. Mandi has nine...