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
Conclusion
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