Leases are an integral part of today’s business environment. However, lessees did not report most leases on the balance sheet and only disclosed future lease payments in the notes to the financial statements. This has changed dramatically with the introduction of the new accounting standards for lease accounting under US GAAP and IFRS, which require lessees to recognize most leases on-balance.
To ensure a systematic approach to lease accounting, the International Standards Board (IASB) and the Financial Accounting Standards Board (FASB) started a joint project in 2006 to develop new regulations for lease accounting. In 2016, the boards issued new standards, namely, ASC 842 and IFRS 16.
Non-public companies in the US must adopt ASC 842 for fiscal years beginning after December 15th, 2021. Companies preparing financial statements under IFRS have already applied the IFRS 16 accounting standard in 2019. Although the development of the new guidance began as a joint project, there are significant differences between final standards.
In this blog post, we explain the key differences in lease accounting between IFRS 16 and ASC 842 for both lessees and lessors.
Table of contents
1. Scope and recognition exemptions under IFRS 16 and ASC 842
Only ‘Property, Plant and Equipment’ (PPE) is in the scope of ASC 842.
Under IFRS 16, lessees may also apply the standard to leases of intangible assets.
In addition, IFRS 16 contains two key practical expedients for lessees:
- Short-term leases with a lease term of 12 months or less and
- Leases of low-value assets
For such types of leases, lessees may choose not to recognize a right-of-use asset and a lease liability and expense the lease payments on a straight-line basis.
However, under ASC 842 this accounting policy choice applies only to short-term leases.
2. Single model vs. dual model for lessees
Under ASC 842, lessees must classify each lease as either
- Operating lease
- Finance lease
Under IFRS 16, however, there is no distinction between operating and finance leases anymore.
The distinction under US GAAP is relevant for subsequent measurement and the presentation of amortization and interest expense. However, the recognition of a right-of-use asset and a lease liability is required for both operating and finance leases.
Finance leases under ASC 842
Lessees are required to recognize straight-line amortization of the right-of-use asset and interest expense on the lease liability as separate line items in the income statement.
As the total lease expense is higher in the beginning of the lease term, there is a so-called “front-loading effect” in the income statement. This is due to straight-line amortization and decreasing interest expense.
Under IFRS 16, all leases are accounted for as “finance leases”.
Operating leases under ASC 842
For operating leases, lessees recognize a single periodic lease expense in operating activities which represents the allocation of lease payments and initial direct costs on a straight-line basis over the lease term. Depreciation and interest expense are calculated for subsequent measurement of lease liability and right-of-use asset, but they are not presented as separate line items in the lessee’s income statement.
The amortization of the right-of-use asset is determined as the difference between the constant lease expense and interest expense. However, after an impairment loss, the right-of-use asset is amortized on a straight-line basis over the remaining lease term which leads to a decreasing periodic lease expense, like under finance leases.
3. Classification requirements for lessors
For lessors, ASC 842 distinguishes between the following lease types:
- Operating lease
- Sales-type lease, and
- Direct financing lease
Please read below for additional information on lease classifications:
Operating leases under IFRS 16 vs. ASC 842
There are no differences between operating leases under IFRS 16 and ASC 842. Lease payments are recognized as lease income on a straight-line basis over the lease term unless another systematic basis is more representative of the pattern in which benefit is expected to be derived from the use of the underlying asset.
Sales-type leases under ASC 842
The accounting for sales-type leases is similar to the requirements of IFRS 16 for manufacturers and dealers, including recognition of revenue, cost of goods sold, and any initial direct costs in the income statement when control of the leased asset transfers to the lessee.
Direct financing leases under ASC 842
For direct financing leases, only selling losses resulting from the lease are directly recognized in the income statement. Selling profit and initial direct costs are deferred and included in the measurement of the net investment in the lease and therefore allocated over the lease term.
More differences between IFRS 16 and ASC 842
In this blog post, we have focused on three key differences between the two lease accounting standards IFRS 16 and ASC 842. However, there are several other factors, which may have a significant impact on the application of the accounting standards, such as:
- Lease modifications
- Transition guidance
- Disclosures for lessees
The spread of the coronavirus also affects the accounting standard IFRS 16. Read which amendments to IFRS 16 the IASB is planning.
When it comes to handling disclosures in line with IFRS 16, LucaNet's leasing tool is a pro. Join us for a look at the key use cases.