In 2008, both the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) implemented a joint project to take a fresh look at the current guidance on accounting for leases and develop a new leasing standard. In January 2016, the IASB issued IFRS 16, Leases, and in February 2016, the FASB issued ASC Topic 842, Leases. The result? The “joint projects” had diverged and different standards were issued, but with many similarities.
In a previous blog post, we looked at some of the main areas (including the classification of leases, initial recognition and measurement, initial direct costs, non-lease components and subsequent measurement) of the new lease standards (ASC 842 and IFRS 16) and identified similarities and differences between U.S. GAAP and IFRS as it relates to lessee accounting. This post will take a look at those same areas and identify the similarities and differences between U.S. GAAP and IFRS as it relates to lessor accounting. Overall, the accounting for lessors under the new standards is similar to the current standards, however there are some differences. It is important to note that those differences are all in the details!
1. Classification of Leases
ASC 842 requires that lessors classify leases as operating, direct financing, or sales-type based on a new lease classification test. The new lease classification is substantially similar to the current IFRS test. Why change the classification test? To remove the “bright lines” that exist under current U.S. GAAP. This will allow for more judgment when determining the appropriate classification of a lease. Why does the classification matter? The accounting for a lease depends on it. We will briefly touch on the accounting of each type later in the blog.
You’ll notice that if any of the criteria are not met, the lessor should classify the lease as an operating lease or direct financing lease. What is the difference between the two? According to KPMG Leases-Issues-in-Depth, which provides significant insight into the new standard, the difference lies with “whether the lessor transfers substantially all of the risks and benefits of ownership of the underlying asset to the lessee or to the lessee and an unrelated third party”. To determine whether or not the lessor transfers substantially all of the risks and benefits of ownership, there is a two-step test. If both of the following criteria are met, the lease is classified as direct financing:
- Present value of the sum of the lease payments + Any residual value guarantee from the lessee or a third-party unrelated to the lessor ≥ Substantially all of the fair value of the underlying asset
- It is probable that the lessor will collect the lease payments plus any amount necessary to satisfy a residual value guarantee.
IFRS 16 requires lessors to classify leases based on the same criteria as ASC 842; however, unlike U.S. GAAP, IFRS only has two classifications: operating and finance, and does not distinguish between sales-type and direct financing. Although there are only two classifications based on the test, there is specific guidance for finance leases that give rise to a manufacturer or dealer lessor’s profit or loss.
In addition to the above classifications, ASC 842 also provides specific classification and accounting guidance for leveraged leases (a lease that is partially financed by the lessor through a third-party financial institution). IFRS 16 provides no special accounting for leveraged leases.
2. Initial Recognition and Measurement
The initial recognition and measurement of operating leases under ASC 842 and IFRS 16 is the same: continue to recognize the leased asset on the balance sheet and recognize the lease payments as income, generally straight-line over the lease term.
The initial recognition and measurement of direct financing leases (U.S. GAAP), sales-type leases (U.S. GAAP) and finance leases (IFRS) all differ. We’ve summarized the initial recognition and measurement of these leases in the table below.
3. Initial Direct Costs
Under both U.S. GAAP and IFRS, the definition of initial direct costs is the same: incremental costs that an entity would not have incurred if it had not obtained the lease.
Like the definition of initial direct costs, the accounting for initial direct costs for operating leases under both U.S. GAAP and IFRS is also the same: capitalize and amortize over the lease term. However, the accounting for initial direct costs for direct financing leases (U.S. GAAP), sales-type leases (U.S. GAAP), and finance leases (IFRS) all differ. We have summarized the accounting in the table below:
4. Non-lease Components
The accounting for non-lease components is the same under both U.S. GAAP and IFRS. A lease contract may contain lease components, non-lease components (for example, maintenance services), and activities that do not transfer a good or service to the lessee (for example reimbursement by the lessee for property taxes incurred and paid by the lessor). ASC 842 and IFRS 16 only apply to the lease components. As such, U.S. GAAP and IFRS require entities to separate lease components from non-lease components in a lease contract. For lessors, the consideration in the lease contract is allocated between the lease components and non-lease components based the new price allocation guidance included in the new revenue recognition standards (ASC 606 and IFRS 15). Activities that do not transfer a good or service to the lessee are not considered components of the contract and therefore are not allocated any of the consideration in the contract.
5. Subsequent Recognition and Measurement
The subsequent recognition and measurement of operating leases for lessors under U.S. GAAP and IFRS is the same: requiring lessors to recognize rental income (generally straight line) over the lease term and amortize initial direct costs over the lease term.
In addition, the subsequent accounting of both sales-type leases (U.S. GAAP) and all finance leases (IFRS) is the same: recognize interest / finance income over the lease term any apply impairment considerations to the net investment in the lease, as necessary.
For direct financing leases, U.S. GAAP also requires lessors to recognize interest / finance income over the lease term and apply impairment considerations to the net investment in the lease, as necessary. However, for direct financing leases, U.S. GAAP does not allow lessors to recognize selling profit at lease commencement, and therefore, lessors should recognize selling profit over the lease term.
The new lease standards bring a huge overhaul to the current leasing standards and implementation isn’t going to be easy. Even though ASC 842 isn’t effective until 2019 for public companies and 2020 for all other companies, and IFRS 16 isn’t effective until 2019, it’s important to start getting to know both standards now. For more information, you can check out our post highlighting the 5 biggest changes to lease accounting as a result of the new standards. And while you’re at it, don’t forget to look at our go-to list of resources for the new standards.
If your organization is ready to get up-to-speed on the new standard (either under IFRS or U.S. GAAP), contact GAAP Dynamics today. Whether it’s a full-day workshop, half-day course, or an eLearning, GAAP Dynamics can help you get ahead of the curve in implementing this standard!
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Apr 24, 2018 at 10:53 PM
Can I ask where you got the table under step 3 or where this information is in the FASB codification?
Mike Walworth, CPA:
Apr 24, 2018 at 11:20 PM
Jessica, thanks for your question. I am fairly certain we made the table based on review of the applicable literature. I found the following Codification references related to the accounting for initial direct costs (defined in ASC 842-10-30-9 through 30-10):
-Sales-type leases (ASC 842-30-25-1)
-Direct financing leases (ASC 842-30-25-8)
-Operating leases (ASC 842-30-25-10)
Hope this helps!
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