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14.1A Leases (ASC 840 and IAS 17)
Publication date: 14 Oct 2019
us IFRS & US GAAP guide
The FASB and IASB issued their new leases standards, ASC 842 and IFRS 16, respectively, in early 2016. Those standards are generally applicable for most companies for years beginning in 2019. The guidance in this section describes the similarities and differences between the previously applicable US GAAP guidance (ASC 840, Leases) and IFRS guidance (IAS 17, Leases).
14.1A.1 Lease scope (ASC 840 and IAS 17)
IFRS is broader in scope and may be applied to certain leases of intangible assets.
US GAAP
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IFRS
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The guidance in ASC 840 applies only to property, plant, and equipment.
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The scope of IAS 17 is not restricted to property, plant, and equipment. Accordingly, it may be applied more broadly (for example, to some intangible assets and inventory).
However, the standard cannot be applied to licensing agreements, or leases to explore for or use minerals, oil, natural gas, and similar non-regenerative resources. It can also not be used as a basis of measurement for investment property subject to IAS 40, or to measure biological assets subject to IAS 41.
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14.1A.2 Lease classification—general (ASC 840 and IAS 17)
Leases might be classified differently under IFRS than under US GAAP. Different classification can have a significant effect on how a lease is reflected within the financial statements.
US GAAP
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IFRS
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The guidance under ASC 840 contains four specific criteria for determining whether a lease should be classified as an operating lease or a capital lease by a lessee. The criteria for capital lease classification broadly address the following matters:
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The guidance under IAS 17 focuses on the overall substance of the transaction. Lease classification as an operating lease or a finance lease (i.e., the equivalent of a capital lease under US GAAP) depends on whether the lease transfers substantially all of the risks and rewards of ownership to the lessee.
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The criteria contain certain specific quantified thresholds such as whether the lease term equals or exceeds 75% of the economic life of the leases asset (“75% test”) or the present value of the minimum lease payments equals or exceeds 90% of the fair value of the leased property (“90% test”).
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Although similar lease classification criteria identified in US GAAP are considered in the classification of a lease under IFRS, there are no quantitative breakpoints or bright lines to apply (e.g., 90%). IFRS also lacks guidance similar to ASC 840-10-25-14 with respect to default remedies.
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Events of default must be evaluated pursuant to ASC 840-10-25-14 to assess whether remedies payable upon default are minimum lease payments for purposes of applying the 90% test. The guidance indicates that the maximum amount of potential payments under all non-performance events of default must be included in the lease classification 90% test unless each of the following 4 criteria are met: (i) the covenant is customary; (ii) predefined criteria relating solely to the lessee and its operations have been established for the determination of the event of default; (iii) the occurrence of the event of default is objectively determinable; and (iv) it is reasonable to assume at lease inception that an event of default will not occur.
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Under IFRS there are additional indicators that may, individually or in combination, result in a lease being classified as a finance lease. For example, a lease of special-purpose assets that only the lessee can use without major modification generally would be classified as a finance lease. This would also be the case for any lease that does not subject the lessor to significant risk with respect to the residual value of the leased property.
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For a lessor to classify a lease as a direct financing or sales-type lease under the guidance, two additional criteria must be met: collectibility of the minimum lease payments must be reasonably predictable; and there cannot be any important uncertainty as to the amount of the unreimbursable costs yet to be incurred by the lessor during the lease term.
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There are no incremental criteria for a lessor to consider in classifying a lease under IFRS.
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14.1A.3 Sale-leaseback arrangements (ASC 840 and IAS 17)
Differences in the frameworks might lead to differences in the timing of gain recognition in sale-leaseback transactions. Where differences exist, IFRS might lead to earlier gain recognition.
US GAAP
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IFRS
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The gain on a sale-leaseback transaction generally is deferred and amortized over the lease term. Immediate recognition of the full gain is normally appropriate only when the leaseback is considered minor, as defined.
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When a sale-leaseback transaction results in a lease classified as an operating lease, the full gain on the sale normally would be recognized immediately if the sale was executed at the fair value of the asset. It is not necessary for the leaseback to be minor.
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If the leaseback is more than minor but less than substantially all of the asset life, a gain is only recognized immediately to the extent that the gain exceeds (a) the present value of the minimum lease payments if the leaseback is classified as an operating leases; (b) the recorded amount of the leased asset if the leaseback is classified as a capital lease.
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If the sale price is below fair value, any profit or loss should be recognized immediately, except that if there is a loss compensated by below-market rentals during the lease term the loss should be deferred and amortized in proportion to the lease payments over the period for which the asset is expected to be used.
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If the lessee provides a residual value guarantee, the gain corresponding to the gross amount of the guarantee is deferred until the end of the lease; such amount is not amortized during the lease term.
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If the sale price is above fair value, the excess over fair value should be deferred and amortized over the period for which the asset is expected to be used.
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When a sale-leaseback transaction involves the leaseback of the entire property sold and the leaseback is a capital lease, then underASC 840-40-25-4, the substance of the transaction is a financing and the profit should be deferred until the sale is recognized.
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When a sale-leaseback transaction results in a finance lease, the gain is amortized over the lease term.
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There are onerous rules for determining when sale-leaseback accounting is appropriate for transactions involving real estate (including integral equipment). If the rules are not met, the sale-leaseback will be accounted for as a financing. As such, the real estate will remain on the seller-lessee’s balance sheet, and the sales proceeds will be reflected as debt. Thereafter, the property will continue to depreciate, and the rent payments will be re-characterized as debt service.
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There are no real estate-specific rules equivalent to the US guidance. Accordingly, almost all sale-leaseback transactions result in sale-leaseback accounting. If the leaseback is classified as an operating lease, the property sold would be removed from the seller-lessee’s balance sheet.
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14.1A.4 Leases involving land and buildings (ASC 840 and IAS 17)
More frequent bifurcation under IFRS might result in differences in the classification of and accounting for leases involving land and buildings. In addition, accounting for land leases under IFRS might result in more frequent recordings of finance leases.
US GAAP
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IFRS
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Under ASC 840, land and building elements generally are accounted for as a single unit of account, unless the land represents 25% or more of the total fair value of the leased property.
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Under IAS 17, land and building elements must be considered separately, unless the land element is not material. This means that nearly all leases involving land and buildings should be bifurcated into two components, with separate classification considerations and accounting for each component.
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When considering the classification of land that is considered its own unit of account, ASC 840 would require the lease to be classified as an operating lease unless either the transfer-of-ownership criterion or the bargain-purchase-option criterion is met. In those cases the lessee should account for the land lease as a capital lease.
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The lease of the land element should be classified based on a consideration of all of the risks and rewards indicators that apply to leases of other assets. Accordingly, a land lease would be classified as a finance lease if the lease term were long enough to cause the present value of the minimum lease payments to be at least substantially all of the fair value of the land, even if legal ownership is not transferred.
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In determining whether the land element is an operating or a finance lease, an important consideration is that land normally has an indefinite economic life. Accordingly, in a single lease transaction, the lease of the building and the underlying land may be classified differently.
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14.1A.5 Lease—other (ASC 840 and IAS 17)
The exercise of renewal/extension options within leases might result in a new lease classification under US GAAP, but not under IFRS.
US GAAP
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IFRS
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The renewal or extension of a lease beyond the original lease term, including those based on existing provisions of the lease arrangement, normally triggers accounting for the arrangement as a new lease.
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If the period covered by the renewal option was not considered to be part of the initial lease term but the option is ultimately exercised based on the contractually stated terms of the lease, the original lease classification under the guidance continues into the extended term of the lease; it is not revisited.
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Leveraged lease accounting is not available under IFRS, potentially resulting in delayed income recognition and gross balance sheet presentation.
US GAAP
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IFRS
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The lessor can classify leases that would otherwise be classified as direct-financing leases as leveraged leases if certain additional criteria are met. Financial lessors sometimes prefer leveraged lease accounting because it often results in faster income recognition.
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The guidance does not permit leveraged lease accounting. Leases that would qualify as leveraged leases under US GAAP typically would be classified as finance leases under IFRS.
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It also permits the lessor to net the related nonrecourse debt against the leveraged lease investment on the balance sheet.
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Any nonrecourse debt would be reflected gross on the balance sheet.
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Immediate income recognition by lessors on leases of real estate is more likely under IFRS.
US GAAP
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IFRS
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Under the guidance, income recognition for an outright sale of real estate is appropriate only if certain requirements are met. By extension, such requirements also apply to a lease of real estate. Accordingly, a lessor is not permitted to classify a lease of real estate as a sales-type lease unless ownership of the underlying property automatically transfers to the lessee at the end of the lease term, in which case the lessor must apply the guidance appropriate for an outright sale.
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IFRS does not have specific requirements similar to US GAAP with respect to the classification of a lease of real estate. Accordingly, a lessor of real estate (e.g., a dealer) will recognize income immediately if a lease is classified as a finance lease (i.e., if it transfers substantially all the risks and rewards of ownership to the lessee).
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Additional consideration is required under US GAAP when the lessee is involved with the construction of an asset that will be leased to the lessee when construction of the asset is completed.
US GAAP
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IFRS
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Lessee involvement in the construction of an asset to be leased upon construction completion is subject to specific detailed guidance to determine whether the lessee should be considered the owner of the asset during construction. If the lessee has substantially all of the construction period risks, as determined by specific criterion included in ASC 840-40-55, the lessee must account for construction in progress as if it were the legal owner and recognize landlord financed construction costs as debt. Once construction is complete, the arrangement is evaluated as a sale-leaseback.
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No specific guidance relating to lessee involvement in the construction of an asset exists under IFRS.
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ASC 840 provides guidance with respect to accounting for a “construction project” and can be applied not only to new construction but also to the renovation or re-development of an existing asset.
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