IFRS 16 vs US GAAP (ASC 842): Bridging the gap for Lease Accounting

IFRS (International Financial Reporting Standard )16 has significantly changed the accounting for leases across the globe. Most of the entities are busy managing these impacts for reporting their numbers of the previous financial year.

 One of the easiest ways to manage this transition, is to refer comprehensive analysis of differences with existing GAAP and make necessary changes in Local GAAP numbers to match IFRS requirements.

I have summarized all the critical differences between US GAAP (ASC 842) & IFRS 16 for lease accounting. Please refer the simplified list of differences given below:

• IFRS 16 is applicable for annual accounting period starting on/after 01st April 2019 and entities have to choose option between ‘Full Retrospective method’ & ‘Simplified approach’ (to not restate any previous reported balances and directly taking cumulative impact to the opening retained earnings of current year).

ASC842 is already applicable for all public entities however nonpublic entities have to apply it for annual period starting on/after 15/12/2020. Voluntarily a non-public entity can also apply it earlier. Full retrospective method option is not available for implementing ASC 842 and entities have to apply it through ‘Simplified approach’ only.

• IFRS 16 scope excludes only items which are specifically covered by other standards however US GAAP excludes Inventory related leases, Assets under construction and leases for intangible assets.
• Entities have got option to exclude short term & low value leases in IFRS 16, however US GAAP only allows exclusion of short-term leases. There isn’t any option for entities to exclude low value leases in US GAAP.
• As per IFRS 16, Lessee is not required to classify the leases in Financial or Operating lease category anymore however as per US GAAP entity still needs to classify all the leases in either Financial or Operating category based on specified rules.
• Initial Recognition principal for Lessee: A ‘Right of use’ asset and Liabilities for ‘Lease payments’ have to be recognized initially. We don’t find a significant difference in initial recognition principal as per IFRS 16 and US GAAP.
• Subsequent Recognition of Lease Liability for Lessee: In IFRS 16, lease liability has to be remeasured at amortised cost using effective interest method considering:
  • Lease modifications
  • Changes in Lease payments &
  • Changes caused by Change in index or Rate

As per US GAAP, lease liability has to be remeasured like IFRS 16 only but ‘Changes caused by index or Rates’ can’t be accepted as alone trigger for the remeasurement, unless some other valid triggers are also present.

• Subsequent Recognition of ROU asset for Lessee: in IFRS 16, ROU asset has to be carried at ‘Cost less accumulated Depreciation & accumulated Impairment loss’ OR alternate measurement model of Revaluation OR the alternate model for Investment Properties. In US GAAP, only amortized cost method is allowed and no alternate options are given for financial lease. ROU assets are amortized and this amortization cost is taken to income statement as lease expenses for the operating lease in US GAAP.
• Lease classification for Lessor: In IFRS 16 all leases are classified as financial lease or operating lease at INCEPTION itself however this classification is done at COMMENCEMENT of lease in US GAAP. Financial leases are further classified in ‘Sales type lease’ and ‘Direct Financing lease’ in US GAAP.
• Initially, Lessor Derecognises the Underlying assets from its books and recognises the ‘Net Investment in Leases’ as new assets in IFRS 16 as well as US GAAP.
• If Lessor is a Manufacturer or Dealer: It will recognise seller margin as an outright sale, as per normal accounting policy in IFRS however US GAAP has a different guidance for this recognition. If it’s a direct financing Lease, the seller margin has to be accounted over the lease term, however if it’s a sales type lease, Seller margin has to be accounted based on collectability conditions specified in US GAAP only.
• Accounting for Operating lease in books of Lessor: In IFRS 16 & US GAAP both, lessor recognises the lease rentals as income on straight line basis over the lease term but US GAAP has specified additional guidance to ensure the collectability of consideration, which might trigger change in the recognition method to ‘cash basis’ instead of straight line basis.
• Sales and Lease Back Transactions: IFRS 16 requires testing of change in control, as per principal of IFRS 15 (Revenue Recognition) however USGAAP ASC842 requires this testing to be done as per Revenue codification of US GAAP.

In IFRS 16, if control is established with Lessor/Buyer then only it will treated as per lease accounting principal otherwise it will be accounted as financing only.

In US GAAP, entity additionally needs to consider any repurchase options and check if seller/lessee has classified it as financial lease, to assess change in control to account it as a lease.

• Sub Lease: The arrangement between the head lessor and intermediate Lessee is always treated as a normal lease in IFRS 16 as well as US GAAP however the subsequent lease arrangement between the intermediary lessor and ultimate lessee will be treated differently.
  In IFRS 16, the underlying asset for subsequent lease between the intermediate lessor and ultimate lessee is ‘Right of Use for 1st lease’ however ‘original Asset’ itself is considered as the underlying asset of subsequent lease arrangements in US GAAP.
• Incremental Borrowing rate in IFRS 16 is calculated by taking similar security for borrowing amount equivalent to Right of use asset however in US GAAP it is calculated on the collateralized rate for borrowing an amount equivalent to the lease payments.

Disclosure Differences:

1. In IFRS 16, ‘Right of use’ asset and ‘lease liabilities’ are shown as single line in assets and liabilities of Balance sheet respectively.
   In US GAAP, ‘Right of use’ asset and ‘Lease Liabilities’ are shown in dual line separately for Finance lease and operating lease respectively.
2. In IFRS 16, Amortisation & Interest expenses are shown separately in Income statement however both of these expenses are shown together as lease expenses of continuing operations in income statement prepared under US GAAP.
3. In IFRS 16, Amortisation & Interest expenses are shown under their respective native categories under cashflow statement however both of these expenses are shown as operating cash outflow for Cashflow statement prepared under US GAAP.
4. Specific detailed guidance is available for lease-related expenses like taxes, insurance etc in US GAAP however there isn’t any specific guidance available in IFRS.

I have covered all the critical differences in IFRS 16 & US GAAP for Leases here, however there are more differences at detailed level, which could not be covered in a single article.

I hope this article has helped you to understand the high-level differences and I am happy to further help you with any queries.

The author is a founding partner of Chartered Times and he has over 15+ years of industry experience with several multinational companies. He can also be contacted at mail@charteredtimes.com.