For many reporting entities, leasing is an important way to obtain access to property. It allows lessees to finance the use of necessary assets, often simplifies the disposal of used property, and reduces a lessee’s exposure to the risks inherent in asset ownership.
Leasing guidance (before the issuance of ASU 2016-02
) required lessees to classify leases as either capital or operating leases. Lessees recognized assets and obligations related to capital leases; expenses associated with capital leases were recognized by amortizing the leased asset and recognizing interest expense on the lease obligation. Many lease arrangements were classified as operating leases, under which lessees would not recognize lease assets or liabilities on their balance sheet, but rather would recognize lease payments as expense on a straight line basis over the lease term.
The leasing guidance was often criticized for not providing users the information necessary to understand a reporting entity’s leasing activities, primarily because it did not provide users with a comprehensive understanding of the costs of property essential to a reporting entity’s operations and how those costs were funded. Users frequently analyzed information from a reporting entity’s lease-related disclosures to compare that reporting entity’s performance with other companies. The user community and regulators frequently called for changes to the accounting requirements that would require lessees to recognize assets and liabilities associated with leases.
In 2008, the FASB and IASB (collectively, the “boards”) initiated a joint project to develop a new standard to account for leases. Although many of the perceived problems with the previous leasing guidance related to a lessee’s accounting for operating leases, the boards thought it beneficial to reflect on lease accounting holistically, and to consider lessor accounting while concurrently developing a proposal on revenue recognition (ASC 606, Revenue from Contracts with Customers, which was issued in May 2014).
The FASB issued ASU 2016-02
in February 2016, which was amended in some respects by subsequent Accounting Standards Updates (collectively the “leases standard” or “ASC 842
”). Although the project began as a joint project, the boards diverged in some key areas. Most significantly, the boards did not agree on whether all leases should be accounted for using the same model. After significant deliberation, the IASB decided that lessees should apply a single model to all leases, which is reflected in IFRS 16, Leases
, released in January 2016. The FASB decided that lessees should apply a dual model. Under the FASB model, lessees will classify a lease as either a finance lease or an operating lease, while a lessor will classify a lease as either a sales-type, direct financing, or operating lease.
Under the FASB model, a lessee should classify a lease based on whether the arrangement is effectively a purchase of the underlying asset. Leases that transfer control of the underlying asset to a lessee are classified as finance leases (and as a sales-type lease for the lessor); lessees will classify all other leases as operating leases. In an operating lease, a lessee obtains control of only the use the underlying asset, but not the underlying asset itself.
A lease may meet the lessor finance lease criteria even when control of the underlying asset is not transferred to the lessee (e.g., when the lessor obtains a residual value guarantee from a party other than the lessee). Such leases should be classified as a direct finance lease by the lessor and as an operating lease by the lessee. See LG 3
for information on the dual model adopted by the FASB.
The dual model does not affect a lessee’s initial recognition of assets and liabilities on its balance sheet, but differentiates how a lessee should recognize lease expense in the income statement. The accounting for lessors is largely unchanged under the FASB and IASB models.
Figure LG 1-1 includes a description of some of the most significant differences between the guidance in ASC 842
and IFRS 16.
Figure LG 1-1
Summary of key differences between ASC 842 and IFRS 16
requires a lessee to classify a lease as either a finance or operating lease. Interest and amortization expense are recognized for finance leases while only a single lease expense is recognized for operating leases, typically on a straight-line basis.
Under IFRS 16, lessees will account for all leases in a manner similar to finance leases.
Under ASC 842
, a sale and related profit are recognized upon the commencement of a lease only when the arrangement transfers control of the underlying asset to the lessee, i.e., in a sales-type lease, but not in a direct financing lease. Also, lessors may elect to combine certain nonlease components into the associated lease component.
Under IFRS 16, selling profit is recognized on direct financing leases when performance obligations, defined in IFRS 15, Revenue from Contracts with Customers, have been met. Under IFRS 16, generally lessors may not combine lease and nonlease components.
requires lessees to report the single expense associated with an operating lease as an operating activity.
Under IFRS 16, lessees account for all leases similar to a financed purchase, with payments reported as a financing or operating activity in the statement of cash flows, in accordance with IAS 7, Statement of Cash Flows.
Remeasurement of variable lease payments
The initial measurement of lease-related assets and liabilities is similar under ASC 842
and IFRS 16; however, subsequent changes in lease payments that vary with a rate or index (e.g., rents that increase for changes in an inflation index) are accounted for differently.
Under ASC 842
, such changes are recognized when incurred, unless the lessee is otherwise required to remeasure the lease liability (e.g., as a result of reassessing the lease term).
Under IFRS 16, lease assets and liabilities are remeasured whenever the cash flow changes.
Sale and leaseback accounting
Under ASC 842
, a seller-lessee would recognize the full gain from a sale and leaseback transaction that qualifies as a sale.
IFRS 16 limits the recognition of gains from sale and leaseback transactions.
requires a modified retrospective approach to each lease that existed at the date of initial application as well as leases entered into after that date. A reporting entity must elect whether the date of initial application is the beginning of the earliest comparative period presented in the financial statements, or the beginning of the period of adoption. In the latter case, the reporting entity would not adjust the comparative periods. ASC 842
does not permit a full retrospective approach.
IFRS 16 allows a reporting entity to elect a full retrospective approach, or a simplified approach, but not the modified retrospective approach.
- IFRS 16 has guidance excluding certain leases of low value assets from its recognition and measurement guidance
- IFRS 16 has similar but not identical disclosure requirements
- The accounting for subleases differs in some respects