Lease Accounting

What is Lease Accounting?

Overview

There are various sets of lease accounting standards that govern how companies around the world must account for their leases. The International Accounting Standards Board (IASB) writes the International Financial Reporting Standards (IFRS) that are followed many countries around the world. The Financial Accounting Standards Board (FASB) writes the accounting standards for US GAAP. Recently, the IASB and FASB  came together to create new sets of lease accounting standards.

FASB’s ASC 842 Standard | LeaseAccounting.us

The Current Lease Accounting Standards

The current lease accounting standards are IAS 17 for international filers and ASC 840 for US GAAP filers. They have been in place for decades. Both of these standards divide leases into two main categories, although the naming conventions are slightly different. IAS 17 classifies leases as either finance leases or operating leases. ASC 840 classifies leases as either capital leases or operating leases. Finance and capital leases are substantially the same.

The lease accounting for each type of lease varies. For finance/capital leases, companies must report the leases as an asset and liability on the balance sheet. In addition, they must recognize a depreciation and interest expense for the leases on their income statements. For operating leases, the lease assets and liabilities are not capitalized on the balance sheet. Instead, they are instead recorded in the footnotes of the financial statements as “off-balance sheet leases.” On the income statement, an operating expense is straight-lined over the lease term.

KPMG’s Guide to IFRS 16 | LeaseAccounting.us

The New Lease Accounting Standards

The US SEC ordered a new set of standards as a response to the accounting scandals of the early 2000s. The SEC directed the FASB to work with the IASB to close a major accounting loophole: off-balance sheet leases. The boards developed IFRS 16 for international reporting and ASC 842 for US reporting. Once the new standards are implemented, all companies will need to capitalize their operating leases on-balance sheet as assets and liabilities. The hope is that the change will provide more transparency into the true liabilities of major corporations.

The ASC 842 effective date is the first fiscal year beginning after December 15, 2018 for public companies. Private companies follow a year later on December 15, 2019. IFRS 16 is effective the first fiscal year beginning on or after January 1, 2019 for public companies. Private companies follow a year later.

EY on Applying IFRS 16 | LeaseAccounting.us

Differences in Accounting Treatment Under International and US Standards

While the IASB and FASB’s standards converged in many ways, there are some major differences. The biggest difference is that FASB only chose to require that operating leases are reported on the balance sheet. Otherwise, operating leases follow almost the same accounting treatment as under ASC 840.

However, IASB chose to remove the operating lease classification altogether. All operating leases will follow finance lease accounting unless they meet certain short-term or low-value exceptions.

As a result, the biggest impact to US GAAP filers will be bringing assets and liabilities onto the balance sheet. There will be no change to the income statement because the operating lease expense will be reported the same way.

IFRS filers will experience both the change to the balance sheet and a change to the income statement. The assets and liabilities will be capitalized on the balance sheet just like under US GAAP rules. However, operating lease expense will now be recorded as a front-loaded interest expense plus depreciation expense. This will also impact many of the financial metrics that are dependent on the income statement.