Accounting resources for ASC 842 and IFRS 16

ASC 842, Leases, fundamentally changed the accounting for leases. The goal is to increase transparency and comparability. This means nearly all leases are required to be recognized on the balance sheet!

As you begin your quest to learn more about lease accounting, this page serves as a guide. It brings together a compilation of lease accounting issues, references, and links to various content pieces. This page also includes our lease accounting training courses.

Welcome video

The subsequent accounting will differ depending upon the lease classification.

While the FASB and IASB worked together jointly on these standards, a key difference is in the lessee accounting model. IFRS 16 has a single lessee accounting model. As with U.S. GAAP, nearly all leases under IFRS will be accounted for on balance sheet. However, instead of two classifications for lessees, IFRS requires lessees to account for leases similarly to finance lease accounting under ASC 842.

Identifying contracts that contain a lease

Determining whether a contract is a lease or contains a lease is critical to correctly applying lease accounting. The guidance requires nearly all leases to be recorded on the balance sheet. So, a key risk is that if management does not identify a lease contract, then management will not record it appropriately on the balance sheet.

ASC 842 defines a lease as:

A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.

The definition of a lease requires two key criteria be met:

• There must be an identified asset; and
• The lessee must have the right to control the use of the identified asset

Management determines whether a contract is a lease or contains a lease at inception of the contract. It is not always black and white, so careful consideration of all contracts is important. For example, a service agreement or other contract that is not explicitly labeled as a lease agreement may contain an embedded lease. That embedded lease would need to be accounted for under ASC 842.

Key concepts – lease term, lease payments, and the discount rate

There are a number of key concepts relevant to lease accounting that are important to understand; The lease term, lease payments, and the lease discount rate are three of them applicable to both lessees and lessors. These are integral components to determining the lease liability and ROU asset, and therefore, critical to the accounting for leases.

Lease term

The lease term represents the period of use for the asset. This is the period over which the lease payments will be recognized. Therefore, determining the right lease term will have a direct impact on the recorded lease assets and liabilities.

The lease term is not just the non-cancelable term. Other factors must be evaluated, such as:

• Optional renewal periods
• Periods after an optional termination date
• Lessor options to extend a lease

There is often judgment involved when determining the lease term.

Lease payments

Lease payments are the payments made by the lessee to the lessor for the right to use the underlying asset during the lease term and include the following:

When determining the lease classification, what management includes in the lease payments is essential. It is also essential to the measurement of lease assets and liabilities.

Lease discount rate

The discount rate is important to accounting for leases. Management calculates the present value of the lease payments using the discount rate when:

• Determining lease classification,
• Measuring a lessee’s lease liability, and
• Measuring a lessor’s net investment in a lease for sales and direct financing leases

The lessee uses the rate implicit in the lease as the discount rate, unless the lessee cannot readily determine that rate. In that case, the lessee uses its incremental borrowing rate. Lessees that are not public business entities can use a risk-free discount rate for the lease.

For a lessor, the discount rate for the lease is the rate implicit in the lease.

For additional informational videos on key lease accounting concepts, take a look at our YouTube channel. Subscribe to stay updated as we add videos to the channel. For a more comprehensive understanding of these topics please see our Leases: Overview of ASC 842 course.

Lessee accounting

Initial measurement

At the commencement date of a lease, the lessee calculates and records a lease liability and a right of use asset. This diagram illustrates this calculation:

ASC 842 offers targeted relief for short-term leases through a practical expedient. Entities can elect the practical expedient by class of underlying asset. It defines short-term leases as those with a lease term of 12 months or less that do not include a purchase option for the underlying asset. The practical expedient allows these leases to remain off the balance sheet.

Subsequent measurement

Subsequent account depends on whether the lease is classified as a finance lease or an operating lease. Management determines lease classification by applying the following lease classification test:

Since the lease liability is a discounted amount, the lessee amortizes it using the effective interest method. In addition, lease payments reduce the lease liability when the lessee pays them. The lessee also reduces the ROU asset over the lease term. However, this expense recognition pattern is different for finance and operating leases. For finance leases, the lessee amortizes the ROU asset over the shorter of the lease term or the useful life of the ROU asset. This is usually on a straight-line basis. The goal of an operating lease is to present lease cost on a straight-line basis over the lease term.

Since entities must apply the effective interest method to the lease liability, this results in higher expenses in earlier lease periods. To achieve a straight-line lease cost, lessees adjust the amortization of the ROU asset to produce the desired result. There are two different methods to calculate this amount, however they arrive at the same answer. Our course, Leases: Lessee Accounting Explained provides worked examples of both methods. It also provides a comprehensive understanding of lessee accounting. Other subsequent lessee accounting considerations include impairment considerations for the right of use asset and income tax impacts.

Lessor accounting

Much of the guidance for identifying a lease, lease term and lease payments is similar for both lessors and lessees. Our Leases: Overview of ASC 842 course covers these concepts for both lessees and lessors. Lessors classify leases as sales-type, direct-financing, or operating based on the results of two interrelated classification tests. The accounting differs depending upon the classification. For example, for both sales-type and direct financing leases, the lessor derecognizes the underlying asset and recognizes a net investment in the lease at lease commencement.

For operating leases, the underlying asset remains on the books of the lessor. ASC 842 provides guidance on the accounting for any selling profit or loss that arises for sales-type and direct-financing leases. One of the complicating issues with lessor accounting is the discount rate. Lessors will always use the rate implicit in the lease. However, there may be up to three variations of this rate used by lessors to accurately account for the lease. Our course Leases: Lessor Accounting Explained provides a comprehensive understanding of lessor accounting, including worked examples of the three types of leases.

Accounting for changes after the commencement date

Change happens! Lease terms and agreements do not always remain the same throughout the original lease term. When changes take place after the commencement date, there are accounting implications and consequences.

ASC 842 defines when entities must reassess a contract. It also defines when they must remeasure the lease liability and ROU asset during the lease term.

It also provides specific guidance on accounting for lease modifications, which occur when changes to a contract’s terms and conditions alter the lease’s scope or consideration. For example, modifications may add or terminate the right to use assets or adjust the lease term.

When lease modifications take place, lessees and lessors must determine whether the modified lease is accounted for as a separate contract or not based on whether:

• The modification grants the lessee an additional right-of-use that was not included in the original lease; and
• The lease payments are priced commensurate with the stand-alone price of the additional right-of-use, adjusted for the circumstances of the contract

These two criteria show that the lessee and lessor have effectively entered into a new arm’s-length transaction, independent of the existing contract. If the modification meets both conditions, the entity accounts for the modification as a separate contract.

Our course, Leases: Changes After The Commencement Date provides an in-depth look at this guidance.

Other considerations

ASC 842 provides guidance on other specific lease accounting considerations such as contract combinations, separating components of a contract, accounting for initial direct costs of a lease, sale-leaseback transactions, sublease arrangements, and many more!

Lease presentation and disclosure

One of the key goals of ASC 842 is to ensure transparency in financial reporting by providing a faithful representation of the rights and obligations arising from leases. To meet this goal, the standard requires certain presentation and disclosures.

A lessee must present right-of-use assets and lease liabilities separately for finance leases and operating leases. This can be done either on the balance sheet or disclosed in the notes. For finance leases, right of use asset amortization is presented consistent with depreciation or amortization of similar assets. Interest expense is presented for the amortization of the lease liability. For operating leases, a single lease expense is presented in the income statement as an operating expense. A lessor must present lease assets (that is, the aggregate of the lessor’s net investment in sales-type leases and direct financing leases) separately from other assets in the statement of financial position.

To further the objective for entities to provide information about leases that enable users of financial statements to assess the amount, timing, AND uncertainty of cash flows arising from leases, ASC 842 has some extensive disclosure requirements.

ASC 842 requires both quantitative and qualitative disclosures. The more leasing transactions an entity has, the more extensive and comprehensive disclosures must be to meet the needs of their financial statement users.

The FASB and IASB developed ASC 842 and IFRS 16 as part of a joint project. However, there are some critical areas that the Boards did not agree on. As such, while there are many similarities in the standards, there are also differences.

Some of the key differences are:

Lessee accounting model – Dual model vs single model

As discussed above, ASC 842 has a dual model approach for lessee accounting, classifying a lease as either a finance lease or an operating lease which impacts the subsequent accounting. The IASB, on the other hand, went with a single model approach for lessee accounting under IFRS 16 with most leases generally accounted for similar to a finance lease under ASC 842.

Low value exemption

IFRS 16 includes an exemption for leases of low-value assets. Instead of recognition on the balance sheet, a lessee may elect to recognize lease payments on a straight-line basis over the lease term. Entities elect this exemption on a lease-by-lease basis. There is no such exemption under U.S. GAAP.

Timing of determining the discount rate

Under ASC 842, both lessees and lessors must determine the discount rate at the lease commencement date.

Under IFRS 16, lessees must determine the discount rate at lease commencement, however, lessors determine the rate implicit in the lease at the lease inception date.

The lease commencement date is the date on which a lessor makes an underlying asset available for use by a lessee. The lease inception date may be different than the lease commencement date. For example, there could be a period of time between the inception date of a lease and when the leased asset is made available, for example, if certain improvements need to be done to the asset before lease commencement.

Index-based variable lease payments

Variable lease payments are payments made by a lessee to a lessor for the right to use an underlying asset that vary because of changes in facts or circumstances occurring after the commence date, other than the passage of time.

When an index-based variable payment adjusts due to a change in the index, IFRS 16 requires a lessee to remeasure the lease liability on the date when the adjustment to the lease payment takes effect. U.S. GAAP does not require remeasurement. Rather, ASC 842 recognizes changes to index or rate-based variable lease payments in the income statement in the period of the change.

Sale and leaseback accounting

In a sale and leaseback transaction, the sale criteria in ASC 606, Revenue from Contracts with Customers, for U.S. GAAP and IFRS 15, Revenue from Contracts with Customers, for IFRS must be met to recognize a sale.

Under ASC 842, a seller-lessee recognizes a gain or loss for the difference between the sales proceeds and the carrying amount of underlying asset.

Under IFRS 16, a seller-lessee recognizes a gain or loss for only the difference related to the right transferred to the buyer-lessor.

GAAP Dynamics training courses help leading accounting firms and multinational companies move beyond the training status quo. We continually update our courses are and add new courses. Check back often! Below are a few of our courses related to leases:

U.S. GAAP courses

Leases: Overview of ASC 842 – Imagine your balance sheet “blowing up” by billions of dollars. Well, that’s what happened when companies implemented ASC 842 Leases. Whether you’re responsible for financial reporting or auditing of financial statements prepared in accordance with U.S. GAAP, you need to make sure you understand the requirements of ASC 842. This CPE-eligible, eLearning course (2.0 CPE) provides you with an overview of accounting for leases including: Identifying “embedded leases” within contracts; determining the lease term, lease payments, and appropriate discount rate; and classifying leases held by both lessees and lessors. The online course concludes with a high-level overview of the accounting for lease by both lessees and lessors.

Leases: Lessee Accounting Explained – Lessees must record (nearly) all leases on the balance sheet in accordance with ASC 842 Leases. However, the subsequent accounting for leases by lessees differs depending on the classification. Take a trip with GAAP Dynamics as we explore the accounting for leases from the lessee’s perspective with this interactive, fun, and example-based eLearning course!Lease accounting has recently gone through a major over-haul with big impacts to entities in all industries…especially if that entity is the lessee in a lease contract! This CPE-eligible, eLearning course (1.5 CPE) uses video, interactivity, and detailed examples to explore all facets of lease accounting for lessees under ASC 842 Leases. Are you ready to jump on board the Leasing Express?

Leases: Lessor Accounting Explained – Lease accounting has recently gone through a major overhaul with big impacts to entities in all industries. While the guidance for lessor accounting didn’t change significantly, it has always been a complex topic – and that certainly did not change! This CPE-eligible, eLearning course (1.5 CPE) uses audio, interactivity, and detailed examples to explore all facets of lease accounting for lessors, including the accounting considerations for sales-type, direct financing, and operating leases. The online course also discusses how other standards impact ASC 842, like ASC 606 Revenue from Contracts with Customers. Are you ready to zoom through the Lessor racetrack?

Leases: Changes After The Commencement Date – You’ve got the lease recorded on the balance sheet under ASC 842. You’re not done there! You need to be on the lookout for certain events that occur after the lease commencement date that may require you to reassess key estimates and judgments about leases, as well as to remeasure lease payments. A lease modification is one such event, but it’s not the only one! Don’t panic! This CPE-eligible, eLearning course (1.0 CPE) covers these things, as well as walks you through the accounting for lease modifications and terminations by both lessees and lessors. And, as always, there are plenty of examples and activities to keep you engaged!

We’ve bundled all these eLearning courses into a US GAAP leases course collection for big savings!

IFRS courses

Leases: Overview of IFRS 16 – To reflect the economic reality of such transactions, IFRS 16 Leases requires lessees to record nearly all leases on their balance sheets. But how? In this CPE-eligible (1.5 CPE), eLearning course you’ll learn how to identify leases within the scope of IFRS 16. You’ll also learn how to record them on the balance sheet. This includes determining the lease term, lease payments, and discount rate. The course concludes with an overview of the accounting for leases by both lessees and lessors. Whether you’re responsible for financial reporting or auditing financial statements under IFRS, this course is a must for the international accountant!

Leases: Lessee Accounting and Application Issues – IFRS 16 Leases requires lessees to record nearly all leases on their balance sheets. But how? In this CPE-eligible (1.0 CPE), eLearning course you’ll learn how to record them on the balance sheet. This includes initial recognition and throughout the lease arrangement. The course concludes with considerations you need to understand if there are changes to the lease arrangement after the commencement date. Whether you’re responsible for financial reporting or auditing financial statements under IFRS, this course is a must for the international accountant!

We’ve bundled all these eLearning courses into an IFRS leases course collection for big savings!

There are numerous resources available on accounting for leases under both ASC 842 and IFRS 16. To save you time searching, we have compiled a list of resources below to assist you in your research and quest to master lease accounting.

Resources from GAAP Dynamics:

GAAP Dynamics wrote several blogs on a variety of lease accounting topics. The list below categorizes many of these blogs. Click on the links to view the full blog post.

ASC 842 – Overview

An Overview of ASC 842 Leases
This blog post provides you with an overview of the requirements of ASC 842 Leases.

Lease accounting key concepts 

Rates, Rates, And More Rates – Lessor Accounting Under ASC 842
What discount rate should a lessor use under ASC 842? This post walks you through the guidance.

Sale and leaseback accounting

Gain Recognition On Sale And Leaseback Transactions Under ASC 842?
Before recording a gain on a sale and leaseback transaction under ASC 842, check out these 5 “red flags” that might cause a failed sale and leaseback.

Taxes and lease accounting

New Lease Accounting Standard (ASC 842 and IFRS 16): CAM and Taxes
This post discusses the accounting for common area maintenance charges (CAM) and property taxes under the new lease accounting standard (ASC 842 and IFRS)

Other accounting for leases issues

Capacity Lease Agreement: Is It A Lease Under 842?
When is a “lease” of capacity considered a lease under the new lease accounting standard (ASC 842)? This post explores the judgments that needs to be considered.

Accounting For Initial Direct Costs Under ASC 842
How do you account for the initial direct costs of obtaining a lease under ASC 842? Read this post to find out.

IFRS 16 VS ASC 842: How To Account For Low-Value Leases
As preparers brace to implement ASC 842 and recover from implementing IFRS 16, let’s take a look at a common issue preparers face: low-value leases.

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