Lease accounting standards for all leases in the U.S. and internationally are set to change in the next few years due to new guidance released by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB). The new lease standards will be based on ASC 842, while international lease accounting will follow IFRS 16. While these new standards have many similarities, there are a few differences as well. The differences could affect companies with operations in the US and abroad, especially if the company has a foreign subsidiary/parent because the Company may be presenting financials under U.S. standards while the parent/subsidiary may be presenting under international standards.
Both standards move a majority of leases to the balance sheet, creating lease liabilities and right-of-use assets. The GAAP standard still allows for differentiation between operating and finance leases, although both will be shown on the balance sheet as noted above, with the difference between the two types of leases relating primarily to how the related lease expense is recorded. IFRS 16 eliminates all operating leases other than for short-term leases (i.e., less than one year) and low-value leases (i.e., less than $5,000). Low-value leases are not explicitly discussed or excluded in ASC 842.
The initial balance sheet amounts to be recorded for all leases are the lease liability and the right-of-use asset. The lease liability will be recorded as the present value of lease payments to be made, discounted at either the rate implicit in the lease, if determinable, or the lessee’s incremental borrowing rate. Under ASC 842, private companies can elect to use a risk-free rate, but this option is not available under IFRS 16. The right-of-use asset will be recorded as the initial lease liability, plus any payments made at or before the commencement date, minus any lease incentive received, plus any other initial direct costs.
The lease expense to be recognized after initial measurement is dependent on the lease type and standard being applied. Financing leases under ASC 842, and all leases under IFRS, have two components to the related lease expense (amortization and interest), while operating leases under ASC 842 have one component (amortization).
First, for financing and IFRS leases, the lease expense will consist of straight-line amortization of the right-of-use asset over the life of the lease. The second component of lease expense for these leases is the interest expense calculated on the lease liability at the interest rate used to discount this liability at initial measurement. Adjustments are made to the right-of-use asset for the calculated depreciation, and the lease liability is first increased by interest expense calculated, then decreased by lease payments made.
GAAP operating leases have a single lease expense component which consists of the straight-line portion of total lease payments plus any initial direct costs incurred by the lessee. The lease liability is first increased by interest as calculated using the rate implicit in the lease or the lessee’s incremental borrowing rate at lease inception, then decreased by lease payments made during the period. The right-of-use asset is adjusted to be the sum of the lease liability plus any unamortized initial direct costs.
In summary, the treatment of leases under the U.S. and international standards that soon will be applied are very similar, with the exception of the exclusions allowed for low-value and short-term leases under the IFRS standard and the allowance for accounting for some leases as operating leases under ASC 842.
Do you have questions about U.S. and international lease standards, or other accounting and auditing issues? Please contact Luke Schmidt at 813-288-8826 or email Luke, or email Nick Kosmela or call Nick at 813-386-3876.