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14.1 Leases (ASC 842 and IFRS 16)
Publication date: 14 Oct 2019
us IFRS & US GAAP guide
The FASB and IASB issued their respective standards in the first quarter of 2016. The issuance of the standards are the culmination of multiple years of deliberating a leasing model with the primary objective of bringing almost all leases onto the balance sheet for lessees. The leases standard was initially intended to be a converged standard; however, the Boards ultimately diverged and as a result there are some differences between the two new standards.
The FASB discussed numerous lease-related questions since issuing ASC 842, and issued five Accounting Standards Updates during 2018 and 2019 relating to: the accounting for easements, certain technical corrections, targeted improvements to the transition provisions, a lessor’s separation of lease and nonlease components, and practical expedients related to the lessor’s accounting for certain taxes and lessor costs paid directly by the lessee.
Summarized below is an overview of the respective leases models highlighting the key differences between the standards.
14.1.1 Embedded leases and scope of the leasing guidance (ASC 842/IFRS 16)
Under both ASC 842 and IFRS 16, even if not a lease in its entirety, an arrangement includes an embedded lease if the contract conveys the right to control the use of an identified asset for a period of time in exchange for consideration. A customer has the right to control the use of an identified asset if it has both (a) the right to obtain substantially all of the economic benefits from use of the identified asset and (b) the right to direct the use of the identified asset. This analysis is performed at the inception of the arrangement and is only reassessed if there is a contract modification.
The IFRS 16 and ASC 842 guidance on identifying whether arrangements are or contain leases is nearly identical. Notwithstanding this, application of the guidance may require significant judgment, and, as a result, the practical application of the principles to similar transactions may differ.
The lease standards provide for certain scope exceptions from the entirety of the guidance. The exceptions to the scope of the lease standards that apply to both US GAAP and IFRS include:
- Leases to explore for or use minerals, oil, natural gas, and similar non-regenerative resources
- Leases of biological assets
- Service concession arrangements
- Certain types of intangible assets
However, there are additional differences in scope between ASC 842 and IFRS 16.
US GAAP
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IFRS
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ASC 842 has a scope exception that excludes all types of intangible assets, leases of inventory, and leases of assets under construction from its scope.
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Under IFRS 16, a lessee may, but is not required to, apply lease accounting to leases of intangible assets other than rights held under licensing agreements within the scope of IAS 38, Intangible Assets. Under IFRS 16, a lessor is required to apply lease accounting to leases of intangible assets other than licenses of intellectual property within the scope of IFRS 15.
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A lessee can make a policy election by class of underlying asset for leases that are short term in nature (i.e., a lease without a purchase option, and with a lease term of 12 months or less). A “short-term” lease that includes extension options may still qualify as a short-term lease, provided the lease term, as defined, is no longer than 12 months. Upon exercise of an extension that was not included in the determination of the original lease term, a lease may still qualify for the short-term lease exemption if the lease term is no longer than 12 months from the expiration of the original lease term.
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Similar to US GAAP, however, upon exercise of an extension not included in the determination of the original lease term, a lease would qualify for the short-term lease exemption only if the remaining lease term is no longer than 12 months at the date of the extension of the lease (i.e., when the lessee notifies the lessor of its decision to extend).
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Entities may be able to establish reasonable capitalization thresholds below which assets and liabilities related to a lease are not recognized, similar to accounting policies in other areas of US GAAP.
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IFRS 16 provides an additional policy election for lessees, on a lease-by-lease basis, to exclude leases of low-value assets from the initial recognition requirements. IFRS 16 does not define the term “low value,” but the Basis for Conclusions explains that the Board had in mind assets of a value of USD 5,000 or less when new.
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Unless otherwise noted, the guidance in this chapter assumes that a lessee is not applying either the short-term or low-value exemptions.
14.1.2 Separating components and combining contracts (ASC 842/IFRS 16)
Contracts often contain multiple obligations of the supplier, which might include a combination of lease and nonlease components. For example, the lease of an industrial space might contain provisions related to the lease of land as well as the existing buildings and equipment, or a contract for a car lease may include maintenance.
When such multi-element arrangements exist, the standards require each separate lease and nonlease component to be accounted for separately unless an entity elects to not separate components (see below). A separate nonlease component exists if a separate good or service (e.g., maintenance) is transferred to the lessee. A separate lease component exists if (a) the lessee can benefit from the underlying asset separate from other lease components and (b) the component is neither highly dependent nor highly interrelated with other lease components in the arrangement.
Once the separate lease and nonlease components have been identified, the consideration in the contract should be allocated to the separate components. The contract consideration is allocated based on relative standalone prices for lessees. Lessors base the allocation on the ASC 606 and IFRS 15 allocation methodologies.
Both ASC 842 and IFRS 16 provide an accounting policy election under which a lessee is not required to separate nonlease components from the lease components and can account for each lease component and any associated nonlease components as a single lease component. This policy election is made by class of underlying asset.
US GAAP
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IFRS
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Under ASC 842, a lessee or lessor accounts for the right to use land as a separate lease component from the right to use a building unless the accounting effect of doing so would be insignificant.
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For a lease of land and building under IFRS, a lessor is required to assess the land separate from the building unless the land element is immaterial to the lease. If lease payments cannot be allocated reliably between land and building, the lease is classified as a finance lease unless it is clear that both elements are operating leases. (Note that this would not apply to lessees as lessees do not classify leases.)
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Lessors can elect, by class of asset, to not separate nonlease components from associated lease components under qualifying circumstances. If elected, the lessor would account for the combined component as either an operating lease under ASC 842, or under the guidance for the nonlease component (e.g., as revenue under ASC 606) depending on which is the predominant component.
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Under IFRS 16, lessors are required to separate lease and nonlease components. Unlike US GAAP, there is no election available.
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Under ASC 842, both lessors and lessees have explicit guidance on allocating consideration between lease and nonlease components. Specifically, both fixed and variable lease payments are allocated between all components based on their relative standalone values (absent appropriately applying applicable practical expedients to combine lease and nonlease components). Lessees and lessors would also allocate consideration that arise from optional subsequent purchases of nonlease components under an arrangement or combined contracts.
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IFRS 16 also requires lessors and lessees to allocate consideration based on relative standalone prices. However, IFRS is not as prescriptive as US GAAP as it relates to whether both fixed and variable payments are each allocated to all components within the arrangements. For example, if an arrangement contains fixed payments that are equal to the standalone rents for the lease component, and variable payments that are equal the standalone price of a nonlease service component (e.g., maintenance of the leased asset), a lessee could elect to assign all the fixed payments to the lease, and all the variable payments to the nonlease maintenance service.
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14.1.3 Lessee accounting – Classification (ASC 842 and IFRS 16)
US GAAP
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IFRS
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Under ASC 842, a lessee can have either a finance or operating lease. If any of the following classification criteria are met, the lease is a finance lease.
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In contrast, under IFRS 16, lessees have only one lease classification, which is similar to the finance lease classification under US GAAP.
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14.1.3.1 Lessee accounting – Balance sheet (ASC 842 and IFRS 16)
Under both standards, lessees record, regardless of the lease classification, a right-of-use asset and lease liability at the lease commencement date. The initial right-of-use asset and lease liability is measured based on the present value of the lease payments (as defined in the standards) using the interest rate implicit in the lease (unless the rate cannot be readily determined, in which case the incremental borrowing rate of the lessee will be used).
However, differences in application exist, as described below.
US GAAP
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IFRS
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To determine the incremental borrowing rate, US GAAP requires the use of a collateralized rate for an amount equal to the lease payments.
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IFRS requires use of a borrowing rate with a similar security to borrow a similar value to the right-of-use asset. The rate should reflect the amount that the entity could borrow to acquire an asset of similar value to the right-of-use asset, rather than to acquire the entire underlying asset. Thus, the incremental borrowing rate under IFRS 16 would be more considerate of a company’s typical borrowing practices (e.g., loan to value considerations).
Under IFRS, if an entity has elected to apply the fair value model under IAS 40, the lessee would also apply that model to subsequently measure the right-of-use assets that meet the definition of investment property. Additionally, if the right-of-use assets relate to a class of property, plant, and equipment measured using the revaluation model under IAS 16, that class of right-of-use asset may also be measured using the revaluation model, if elected.
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14.1.3.2 Lessee accounting – Income statement (ASC 842 and IFRS 16)
Under both US GAAP and IFRS, the income statement recognition for finance leases of lessees consists of the amortization of the right-of-use asset and interest expense related to the lease liability. However, there are differences between IFRS and US GAAP for operating leases.
US GAAP
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IFRS
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Under ASC 842, for operating leases, the amortization of the right-of-use asset and interest expense related to the lease liability are recorded together as lease expense to produce a straight-line recognition effect in the income statement.
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Under IFRS 16, lessees account for all leases like finance leases in ASC 842.
Under IFRS, if an entity has elected to apply the fair value model under IAS 40, the lessee would also apply that model to subsequently measure the right-of-use assets that meet the definition of investment property. The change in fair value will be recognized in the income statement.
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14.1.4 Lessor accounting - Classification (ASC 842 and IFRS 16)
The criteria used for lessor classification of leases are substantially the same between IFRS and US GAAP. However, detailed differences in application exist.
US GAAP
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IFRS
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Under ASC 842, a lease is classified as a finance lease if it meets any one of the lease classification criteria.
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IFRS 16 refers to the criteria used for lessor classification as “examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease.”
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Under ASC 842, a lessor cannot recognize a sales-type lease when collectibility of the lease payments is not probable.
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IFRS 16 does not require the collection of the lease payments to be probable for a lease to be classified as a finance lease.
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The classification of a lease is performed at lease commencement under ASC 842.
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The classification of a lease is performed at the lease inception date under IFRS 16.
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Lessors should apply the sales-type lease classification guidance, even for transactions that contain relatively little fixed consideration. Because a lessor cannot include many variable payments in the measurement of its net investment in a lease, such sales-type leases may result in a lessor recognizing a “Day 1” loss (because lessors would derecognize the entire “sold” asset, but would not recognize a receivable for most variable payments).
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Under IFRS 16, variable lease payments could mean that the lessor does not transfer the risks and rewards of ownership. As a result, such leases may be classified as operating leases, and the asset would not be derecognized, unlike US GAAP.
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There are no leveraged leases under IFRS 16. The leveraged lease concept did not exist under IAS 17, so there is no transition relief.
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14.1.4.1 Lessor accounting – Balance sheet (ASC 842 and IFRS 16)
There are no significant differences between IFRS and US GAAP from a balance sheet perspective. A leased asset is removed from the balance sheet if the lease is classified as a finance lease. It is replaced with a net investment in the lease (comprised of the lease payments and any guaranteed residual value) and the unguaranteed residual value of the asset. If the lease is an operating lease, the lessor leaves the asset on the balance sheet.
14.1.4.2 Lessor accounting – Income statement (ASC 842 and IFRS 16)
Income from operating leases is typically recognized on a straight-line basis under both standards. For finance leases, interest income is recognized on the net investment in the lease. The most significant difference between the standards relates to profit recognition for a finance lease, and impairment models for the net investment in a lease.
US GAAP
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IFRS
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To recognize profit at the commencement date of a finance lease, ASC 842 requires the lessor to transfer control of the asset to the lessee (a third-party provided residual value guarantee is not a factor in this determination).
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Transfer of control is not a requirement under IFRS 16 to recognize profit under a finance lease for manufacturer and dealer lessors.
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ASC 842 contains explicit guidance regarding the collectibility of lease payments. If collectibility is not deemed probable at lease commencement, a lessor would not recognize a sales-type lease, and would not recognize lease income in excess of its cash receipts.
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IFRS 16 does not contain guidance around the collectibility of lease payments.
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Impairment of a net investment in a lease, excluding any unguaranteed residual value, is governed by the credit loss guidance in IFRS 9. Lessors review unguaranteed residual values under the explicit guidance in IFRS 16. In case of a reduction in the value, the income allocation over the lease term is revised and any reduction with respect to amounts already accrued would be recognized immediately.
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14.1.5 Lease re-assessments and modifications (ASC 842 and IFRS 16)
The guidance for lease re-assessments and modifications is similar under both standards, except for changes in an index or rate.
US GAAP
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IFRS
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Under ASC 842, a change in the lease payments that occurs as a result of a change in an index or rate is not a reassessment and remeasurement event.
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Under IFRS, a change in the lease payments that occurs as a result of a change in an index or rate triggers a reassessment and remeasurement of the lease.
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When a modification decreases the scope of a lease other than to shorten the lease (e.g., reduces the amount of space leased), both standards require the lessee to remeasure the lease liability, adjust the right-of-use asset, and recognize a gain or loss. When calculating the gain or loss under ASC 842, the lessee may adjust the right-of-use asset by either the reduction in the right of use, or by the percentage change in the premodification lease liability.
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Under IFRS, when a modification decreases the scope of a lease, the lessee adjusts the right-of-use asset by the reduction in the right of use to calculate the gain or loss.
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A lessee recognizes the change in lease liability resulting from a modification that shortens the lease term (other than through the exercise of a pre-existing contractual option) as a corresponding change in the right-of-use asset, and records a gain or loss when the right-of-use asset is reduced to zero.
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A lessee accounts for a modification that shortens the lease term in the same manner as any other modification that decreases the scope of a lease, i.e., it calculates and recognizes a gain or loss.
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14.1.6 Sublease transactions (ASC 842 and IFRS 16)
US GAAP
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IFRS
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When classifying a sublease, the asset analyzed under ASC 842 is the underlying asset.
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Under IFRS 16, when classifying a sublease, the asset analyzed is the right-of-use asset from the head lease.
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For example, if an entity is the lessee in a five-year lease of an office building and then enters into a sublease for the entire five-year lease term, under US GAAP, the entity compares the sublease to the underlying building.
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For example, if an entity is the lessee in a five-year lease of an office building and then enters into a sublease for the entire five-year lease term, under IFRS, the entity compares the sublease to the five-year right-of-use asset.
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14.1.7 Sale and leaseback transactions (ASC 842 and IFRS 16)
The accounting for sale-lease back transactions is symmetrical between a buyer-lessor and a seller-lessee under the standards.
In a sale-lease back transaction, the seller-lessee follows sale-lease back accounting when the sale criteria in ASC 606 (for US GAAP) or IFRS 15 (for IFRS) are met.
If a sale is recognized, the transaction is measured based on the fair value of the asset transferred. Any proceeds from the sale that are either above or below the fair value of the asset will be treated as a financing or prepaid rent. The asset is removed from the balance sheet and replaced with a right-of-use asset and lease liability. If a sale is not recognized, the arrangement is treated as a financing. However, certain detailed differences in application exist.
US GAAP
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IFRS
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Under ASC 842, the seller-lessee’s gain recognized at the sale date will be measured as the difference between the adjusted sale proceeds (total proceeds less any financing component) and the book value of the asset transferred. The right of use asset arising from the leaseback is measured under the normal ASC 842 principles.
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Under IFRS 16, the gain (or loss) is limited to the proportion of the total gain (or loss) that relates to the rights transferred to the buyer-lessor. The right-of-use asset arising from the leaseback is measured as the proportion of the previous carrying amount of the asset that relates to the right of use retained.
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ASC 842 contains guidance for build-to-suit accounting for the lessee. The criteria focus on control during the construction period.
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IFRS 16 does not contain guidance for build-to-suit accounting for lessees during construction period.
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14.1.8 Presentation and disclosure (ASC 842 and IFRS 16)
For lessees, the presentation of the right-of-use assets and lease liabilities are similar under the standards. Amounts relating to leases are presented separate from other assets and liabilities on the balance sheet or in the notes to the financial statements. However, some detailed differences in application exist.
US GAAP
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IFRS
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ASC 842 prohibits right-of-use assets and lease liabilities related to operating leases from being presented in the same balance sheet line item as those arising from finance leases.
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This requirement does not exist under IFRS, since there is no lease classification for lessees.
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ASC 842 requires presentation of operating lease expense within income from continuing operations.
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Under IFRS, amortization and interest expense are required to be presented in separate line items by the lessee.
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Under ASC 842, lessees will typically present payments under operating leases within operating activities in the cash flow statement, since interest and depreciation are not presented in the income statement for operating leases.
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Under IFRS, amortization and interest are presented separately in the cash flow statement and follow their respective classification guidance.
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ASC 842 contains incremental guidance and accounting elections related to how lessors should account for lessor costs (such as property taxes and insurance of the leased asset) that are paid for directly by a lessee. There are practical expedients that allow lessors to report certain of these costs on a net basis.
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There is no specific guidance under IFRS for these items.
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14.1.9 Transition (ASC 842 and IFRS 16)
US GAAP
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IFRS
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ASC 842 is effective for public business entities (“PBEs”) for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years, and for fiscal years beginning after December 15, 2019 for non PBEs In August 2019, the FASB exposed a proposal to allow non-PBEs an additional year to adopt ASC 842.
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IFRS 16 is effective for periods beginning on or after January 1, 2019.
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ASC 842 does not permit a full retrospective adoption. It provides for a single transition approach: a modified retrospective application with the option to elect hindsight and/or a package of practical expedients. Entities may elect not to restate the comparative prior periods (similar to the IFRS 16 “simplified approach”).
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IFRS 16 allows full retrospective application (with certain exceptions), as well as a “simplified approach” in which the comparative periods are not restated and the cumulative effect of applying the new standard is recorded as an adjustment to the opening balance of retained earnings.
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Under both ASC 842 and IFRS 16, a lessee or lessor may elect, as a practical expedient in transition, to not reassess whether an arrangement is or contains a lease. However, under ASC 842, entities may only elect to use this expedient as part of a “package” of expedients to also not reassess lease classification, or existing initial direct costs.
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A similar election exists under IFRS 16, but it is not part a package of expedients (as required under US GAAP).
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A lessee or lessor may apply hindsight when determining lease term, or impairment of right-of-use assets. If elected, it must do so for all of its leases, whether as a lessee or lessor.
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Under IFRS 16, when using the “simplified approach,” a lessee (but not a lessor) may apply hindsight to lease term, impairment, and other areas involving judgment or estimation, e.g., dismantling costs. A lessee may apply these practical expedients on a lease by lease basis.
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Under ASC 842, an entity electing to use the “package” of practical expedients would generally not alter its allocations of consideration in the arrangement.
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Under IFRS 16, an entity can elect to allocate consideration in an arrangement containing a lease using stand-alone selling prices at either the commencement date of the lease or the transition date.
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Entities that previously reported “good” sale and leaseback transactions do not reassess those transactions upon adopting ASC 842. Lessees that “failed” sale and leaseback transactions (this does not apply to lessors, as the previous leases guidance was not symmetrical) reassess whether those transactions meet the sale and leaseback guidance in ASC 842 before its effective date. If so, lessees retroactively account for the sale and leaseback as of the later of the beginning of the earliest period presented, or the date the transaction qualified as a sale under ASC 842 (or the date they apply ASC 842, if they elect not to restate prior periods).
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Entities that elected to use a full retrospective approach nevertheless do not retrospectively apply IFRS 16 guidance to pre-adoption sale-leaseback transactions, or to pre-adoption business combinations, but, instead, apply the specific transition guidance in IFRS 16.
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Entities only reassess initial direct costs if they do not elect to use the “package” of practical expedients.
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Under IFRS 16, lessees do not classify leases; and, if using the “simplified approach,” they can separately elect to exclude initial direct costs from the measurement of the right-of-use asset.
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Under US GAAP, entities are allowed to not revisit the accounting for easement arrangements that existed at the transition date that were not previously accounted for as leases. However, easement arrangements entered into or modified after the effective date of ASC 842 would have to be evaluated under the new lease identification guidance.
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The IASB has not provided equivalent relief for easement arrangements.
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