Understanding One of the Biggest Accounting Changes in History
Overview of the New Lease Accounting Standards
The lease accounting standards govern how companies around the world must account for their leases have recently been updated. The International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) came together to create new sets of lease accounting standards, IFRS 16 and ASC 842.
The Previous Lease Accounting Standards
The previous lease accounting standards were IAS 17 for international filers and ASC 840 for US GAAP filers. Both of these standards divided leases into two main categories, finance and operating for IAS 17 and capital and operating for ASC 840. Finance and capital leases are substantially the same. The accounting requirements for each type of lease varied. For finance and capital leases, companies must report the leases as an asset and liability on the balance sheet and recognize depreciation and interest expense on their income statements. For operating leases, the lease assets and liabilities were not capitalized. Instead, they were recorded in the footnotes of the financial statements as “off-balance sheet leases.”
The New Lease Accounting Standards
The SEC directed the FASB to work with the IASB to update many of the accounting standards in response to the accounting scandals of the early 2000s. For lease accounting, the boards’ mission was to close a major accounting loophole: off-balance sheet leases. The boards developed IFRS 16 for international reporting and ASC 842 for US reporting. Under the new standards, 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.
Lease Accounting Differences Between IFRS 16 & ASC 842
While the IASB and FASB converged in many ways, there are some major differences.
The main difference is that FASB maintained the dual classification of operating and finance leases, and required companies to report operating leases on balance sheet. However, the IASB chose to remove the operating lease classification altogether. All operating leases must follow finance lease accounting rules unless they meet certain short-term or low-value exceptions.
As a result, the biggest impact to US GAAP filers will be from moving assets and liabilities onto the balance sheet. There will be essentially no change to the income statement. IFRS filers will experience the same change to the balance sheet. However, they will also see their income statements adjust. The operating lease expense under the previous standard was replaced with a front-loaded interest expense plus depreciation expense, due to the conversion to finance leases.
EY’s Comparison Guide: IFRS vs US GAAP
EY published an extensive comparison of US GAAP and IFRS accounting rules, pointing out the major differences of the new accounting standards, including lease accounting, revenue recognition, and derivatives and hedging.