lease

Lease Accounting: Comparing ASC 842 to IFRS 16

At the beginning of 2006, FASB and IASB came together to reconcile lease accounting standards with the objective to synchronize the lease reporting between GAAP and IFRS. The joint project came to its culmination with two new standards: IASB’s international standard (IFRS 16, Leases) and the U.S. GAAP standard (FASB’s Accounting Standard Update (ASU) No. 2016-02 Leases, Topic 842). Although the requirements from both standards are mostly similar in Day One accounting in terms of lease definition, there is a significant divergence in the Day Two lessee accounting and transition provisions. The issue is of paramount importance, especially for dual reporting businesses due to the complexities in process implementation, control, and systems. Below are five notable differences between IFRS 16 and ASC 842.

Definition of Lease

Lease definition is one of the major differences between GAAP and IFRS lease accounting standards. IASB no longer differentiates between operating and finance leases. IFRS 16 applies a single lessee accounting model analogous to finance leases under current IAS 17. Hence, from the perspective of profit and loss, IFRS treats all leases as financing arrangements. Therefore, companies apply a single on-balance sheet lease accounting model. 

Contrary to IASB, FASB differentiates between an operating lease and a finance lease. ASC 842 assesses a lease in comparison to five criteria. If an asset meets any of the five, then the transaction is treated as a finance lease. Subsequently, US GAAP classifies only finance leases as financing arrangements from P&L perspective. While all the leases are reported as RoU assets and liabilities on the balance sheet (similar to IFRS), in the case of a finance lease, businesses must recognize interest on the lease liability separately from the amortization of the right-of-use asset in the income statement. In the case of an operating lease, straight-line total lease expense is recognized in the Day Two accounting.

Variable Lease Payments

Another key difference that companies shall address in the implementation of the two accounting models is the accounting for lease payments that change depending on an index or reference rate. In a simple equipment lease, assume that lease payments fluctuate with the corresponding change in the consumer price index every period. IFRS requires companies to remeasure the liability amount each year to reflect the most up-to-date CPI. Whereas the US GAAP does not require the lessee to adjust the liability for changes in the CPI. Instead, the lessee shall recognize additional expenses in the income statement. For example, if in year 3 of the lease, the lease payments increased by $100 due to a change in CPI, the lessee shall recognize the additional $100 in the current period income statement and not remeasure the lease liability. As a result, the liability under IFRS could grow considerably greater than the liability under US GAAP, which will overstate the balance sheet difference.

Low Value or Immaterial Threshold

Another key difference between the GAAP and IFRS standards is the issue of materiality. Under IFRS lessees may choose to apply the recognition exemption for leases of immaterial assets such as computers and phones even if they are material when combined. IASB quoted a threshold of $5,000 as a parameter to use to assess materiality. For GAAP-compliant companies, there is no exemption for leases of low-value assets.

Transition Approach and Comparatives

US GAAP and IFRS each require different approaches for transition accounting within the new leasing standard. US GAAP requires one approach – the modified retrospective approach. Under IFRS lessees can elect to restate comparatives in – retrospective approach or without restating comparatives – modified retrospective approach. According to IFRS if a company selects retrospective approach, it shall restate comparatives. For example, the company would restate the 2017 and 2018 results within its 2019 financial statements for comparative purposes. Similar to IFRS, lessees can choose to restate comparatives – comparative method or adopt ASC 842 without restating comparatives (effective date method). A Series of exemptions or practical expedients can be applied for lessees both complying IFRS and US GAAP.

Sale-leasebacks

One more difference between GAAP and IFRS relates to sale-leaseback transactions. Under IFRS If the seller-lessee has a substantive option to repurchase the leased asset, the reports shall not recognize the transfer as a sale. To recognize a leaseback transaction as a sale it shall meet the requirements for determining when a performance obligation is satisfied in IFRS 15, Revenue from Contracts with Customers. According to GAAP if the seller-lessee has a substantive option to repurchase an underlying asset that is not real estate the transfer can be recognized as a sale under certain circumstances (Topic 606, Revenue from Contracts with Customers). If the leaseback is classified as a finance lease by a seller-lessee (or as a sales-type lease by the buyer-lessor), then sale recognition is automatically precluded.

Effective Dates

IASB required that both public and private businesses comply with IFRS 16 effective from 2019. With US GAAP, however, the deadline to comply was different for public and private companies. Public companies had to adopt ASC 842 from 2019. Private companies have until December 15, 2021, to adopt the new standard.

Conclusion

In summary, both IFRS and GAAP leasing standards generally reached the objective to unify lease accounting on Day One accounting. However, the Boards’ views diverged over the course of the project and resulted in significant differences on Day Two lessee accounting and transition provisions. Hence the differences between the GAAP and IFRS standards require careful analysis of the lease portfolio, specifically for US-based businesses with international operations.

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  1. Implementation Guide
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  3. Required documentation gathering and indexing
  4. Schedule setup and maintenance
  5. Audit review assistance

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Narek
Narek Abgaryan
Narek is the CEO of Hundred MS. Before embarking upon this position, he accumulated insightful experience including the positions of CEO, Head of Research and Member of the Board at various licensed and regulated investment companies. Narek is a graduate of Hult International Business School, Armenian State University of Economics and is currently pursuing his education at Saïd Business School of the University of Oxford. Narek is a CFA charter holder and a certified FRM.
CFA, FRM
Corporate Finance Investment Performance Management
Narek Abgaryan
Narek is the CEO of Hundred MS. Before embarking upon this position, he accumulated insightful experience including the positions of CEO, Head of Research and Member of the Board at various licensed and regulated investment companies. Narek is a graduate of Hult International Business School, Armenian State University of Economics and is currently pursuing his education at Saïd Business School of the University of Oxford. Narek is a CFA charter holder and a certified FRM.
CFA, FRM
Corporate Finance Investment Performance Management
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Our Vision
We have a deep conviction that the financial system is the pillar of our civilizations. Economies that are exploding with growth are the ones that adopted modern finance. We aim to reach a reality where access to unconventional finance technics should be within reach of every economic unit. This shall empower everyone to allocate their human and financial capital more purposefully and innovatively for the benefit of a secure, wealthy, and responsible society.
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Objectives
In "Hundred MS", we are structuring our goals to revolve around the best interests of our investors and business partners. The basis we build our strategy on is satisfaction of expectations of our Clients, by bringing substantial profits to them through ethical management of investments, assets and portfolios. In the path of achieving the set tasks, we target new financial products adapted to the Client’s needs and offer variety combinations of interdisciplinary innovations. Following our set of values, we see our short-term goal in becoming one of the leading players in the global financial markets.
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We believe that earning the trust of each Client cements the next layer of the foundation of the Company’s reputation. Financial relations are built on trust; thus, our reputation is the heart of our business. Our allocentric approach to dealing with clients ensures that we always put their interests first. We do our utmost to make sure that our decisions are utterly disconnected from the greed when it comes to rendering our services. Promulgating ethics and adhering to the highest professional standards are the bedrocks of our corporate values.
Corporate Values
We believe that earning the trust of each Client cements the next layer of the foundation of the Company’s reputation. Financial relations are built on trust; thus, our reputation is the heart of our business. Our allocentric approach to dealing with clients ensures that we always put their interests first. We do our utmost to make sure that our decisions are utterly disconnected from the greed when it comes to rendering our services. Promulgating ethics and adhering to the highest professional standards are the bedrocks of our corporate values.
Levon
Levon Garibyan
Levon is the Business Development Director and Strategy Specialist of the company. He acquired international experience of more than 10 years, managing private firms with various business profiles in UK, UAE and Russian Federation. Levon studied in Cranfield University School of Management and Moscow State University of International Affairs (MGIMO).
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Levon Garibyan
Levon is the Business Development Director and Strategy Specialist of the company. He acquired international experience of more than 10 years, managing private firms with various business profiles in UK, UAE and Russian Federation. Levon studied in Cranfield University School of Management and Moscow State University of International Affairs (MGIMO).
MSc
Business Development, Strategy & Fundraising
David
David Tarkhanyan
David is the co-founder of Hundred MS. He is a Banking specialist with a focus on Financial Controlling, Planning, and Performance Management. His experience extends more than 10 years in various investment banks in Vienna and Frankfurt. David studied Physics at Bauman University and Industrial Engineering at the American University of Armenia.
CFA, FRM
Financial Controlling Investment Banking
David Tarkhanyan
David is the co-founder of Hundred MS. He is a Banking specialist with a focus on Financial Controlling, Planning, and Performance Management. His experience extends more than 10 years in various investment banks in Vienna and Frankfurt. David studied Physics at Bauman University and Industrial Engineering at the American University of Armenia.
CFA, FRM
Financial Controlling Investment Banking