Beginning in 2006, there was a concerted effort by the two accounting standard bodies (FASB and IASB) to synchronize their respective standards on leasing to assure consistency and uniformity. The effort culminated last year with the release of the 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).
While the two standards are closely aligned, particularly relating to putting lease assets and liabilities on the balance sheet, there are significant differences between IFRS and GAAP.
In this article, we’ll explore the key difference between GAAP and IFRS when it comes to lease accounting under the new standards.
Defining a lease
Perhaps the most significant difference between the GAAP and IFRS lease standards is the definition of a lease. The FASB/U.S. GAAP standard differentiates between an operating lease and a finance lease while the IFRS standard considers all leases as finance leases.
Under the new FASB standard, both types of leases require a lessee to put a right-of-use asset and a lease liability on the balance sheet. However, in the case of a finance lease, interest on the lease liability is recognized separately from the amortization of the right-of-use asset in the income statement. For an operating lease, a single lease cost, generally allocated on a straight-line basis over the lease term, is presented in the income statement.
Another key difference between the GAAP and IFRS standards is the issue of materiality. The IFRS standard maintains an exemption for low value assets such as telephones and computers. A threshold of $5000 was cited by the IASB as a parameter to use to assess materiality. The US GAAP standard doesn’t specify a cost level but allows that lease assets that are considered immaterial, need not be capitalized.
Another key difference between the GAAP and IFRS standards relates to the classification of a sublease. FASB’s ASU No. 2016-02 requires an initial lessee that subleases the underlying asset, therefore becoming a sub-lessor, to determine the classification of the sublease by referencing the leased asset in the original lease. IFRS 16 requires that the sub-lessor determine the sublease classification by referencing the right-of-use asset that arose from the original lease.
Variable lease payments
Another key difference between the GAAP and IFRS standards centers on the question of variable lease payments. Lessees are required to measure these variable lease payments initially at the index or rate on the lease commencement date. The remeasurement of these payments, however, differs under the two bases of accounting. Under US GAAP, a lessee remeasures the payments only when it is required to reassess the lease obligation for other purposes. IFRS, however, requires an entity to remeasure these payments every time an adjustment to the lease payments takes effect.
Defining lease term
Both standards permit a lessee to apply a short-term lease exemption for a lease with a term of 12 months or less. However, there’s a difference between GAAP and IFRS when it comes to the definition of a lease term.
In determining the lease term, a lessee excludes purchase options that it is reasonably certain to exercise under US GAAP. A lessee excludes all purchase options from this determination under IFRS.
Another key difference between GAAP and IFRS is related to sale leaseback transactions.
A sale and leaseback transaction is not a sale under US GAAP if it does not satisfy the sale requirements in Topic 606, Revenue from Contracts with Customers. If the transaction is a sale, the seller-lessee can recognize the entire gain on the transaction.
Under IFRS, a sale and leaseback transaction is not a sale if it does not meet the requirements for determining when a performance obligation is satisfied in IFRS 15, Revenue from Contracts with Customers (similar to Topic 606 under US GAAP). If the transaction is a sale, the seller-lessee can only recognize a gain for the amount that relates to the buyer-lessor’s residual interest in the leased asset at the end of the leaseback.
Difference between GAAP and IFRS lease standards: Good news and bad news
In summary, the good news is that the IFRS and GAAP leasing standards are quite similar and address the primary objective of the new standards: to make the leverage effect of leasing more transparent. But the bad news is that there are differences between the GAAP and IFRS standards requiring careful analysis of the lease portfolio, particularly for US based companies with international operations and leases.
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