IFRS 16 vs. US GAAP Lease Accounting: What Are the Differences?
The changes in leasing regulations have started as a joint project between the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB). In the course of this project, however, significant differences between IFRS16 and ASC842 arose which dual-reporters have to take into consideration.
The most important difference is that US-GAAP still distinguishes between financial and operational leases. Both leasing types require the creation of a RoU-asset and lease liability. The different treatment can be found on the level of the depreciation for operational leases under US-GAAP, whereby the lease expense will be presented as a straight-line expense over the lease term.
Another important difference is the effective date, whereas IFRS16 will become effective as of 1st January 2019 and ASC842 is effective for annual periods beginning after 15th December 2018.
Other differences exist on the level of transition approach, the definition of a lease, exemption of low value assets, sale-leaseback transactions, subleases, etc. While similar with regards to the recognition of leases in the Balance Sheet, the standards have many differences in application. Below are five notable differences between IFRS 16 and ASC 842.
𝟭: 𝗘𝗳𝗳𝗲𝗰𝘁𝗶𝘃𝗲 𝗗𝗮𝘁𝗲𝘀
IASB mandated that public and private companies both had to comply with IFRS 16 on the same effective date: fiscal year ends after December 15, 2018. With U.S. GAAP, however, the deadline to comply was different for public and private companies. Public companies had to adopt ASC 842, for fiscal years after December 15, 2018. Whereas the effective date of ASC 842 for private companies is for fiscal years ending after December 15, 2020.
𝟮: 𝗧𝗿𝗮𝗻𝘀𝗶𝘁𝗶𝗼𝗻 𝗔𝗽𝗽𝗿𝗼𝗮𝗰𝗵
U.S. GAAP and IFRS each require different approaches for the transition accounting within the new leasing standard. U.S. GAAP requires one approach – the modified retrospective approach. However, this approach can be done with or without comparative periods. ASC 842 prescribed adoption of the standard with comparative information presented. For example, if a calendar year public company adopts the standard as of January 1, 2019, the Company would restate the 2017 and 2018 results within its 2019 financial statements for comparative purposes. However, the FASB provided a popular practical expedient which allows companies to adopt the guidance as of the effective date (i.e. beginning of the fiscal year) which allows a company to avoid the recast of historical information.
IFRS offers two approaches to account for the transition. This first approach is the full retrospective approach. The full retrospective approach is applied at lease commencement and therefore, requires companies to restate all periods dating back to the oldest lease currently active as of transition as if the entity had always applied IFRS 16. For example, if an entity’s oldest active lease as of transition began in the year 2000, then the company would apply the guidance to its identified leases beginning in 2000, and then restate financials for every year affected, from 2000 to 2019.
The second approach, the cumulative approach, can be done two different ways, but is very similar to U.S. GAAP’s modified retrospective approach. This first option accounts for the transition as of the beginning of the current period. One approach requires a company to calculate the lease liability at transition and then the right of use asset equals the liability. This approach does not have an equity adjustment, and in our experience, most companies tend to opt for this approach. Another option within the cumulative approach calculates the lease liability and corresponding ROU asset as of the commencement date of the lease as if IFRS 16 had always been applied with a corresponding equity adjustment recorded for the difference.
𝟯: 𝗟𝗼𝘄 𝗩𝗮𝗹𝘂𝗲 𝗧𝗵𝗿𝗲𝘀𝗵𝗼𝗹𝗱𝘀
Under IFRS, lessees do not have to account for leased assets under IFRS 16 that have a value individually of less than $5,000. For example, if a company is leasing computers or golf carts, if these assets are less than this threshold, a company does not need to record the lease on the financial statements.
With U.S. GAAP, however, there is no established threshold in the guidance for immateriality. However, many companies may elect to create a capitalization policy regarding the materiality threshold for which leases will be recorded on the balance sheet.
𝟰: 𝗟𝗲𝗮𝘀𝗲 𝗖𝗹𝗮𝘀𝘀𝗶𝗳𝗶𝗰𝗮𝘁𝗶𝗼𝗻
U.S. GAAP continues to retain two classifications of leases under ASC 842 – operating and finance (formerly capital under ASC 840). Overall, the determination of lease classification under ASC 840 and 842 is similar. Under ASC 842, a lease is evaluated in comparison to five criteria and if an asset meets any of the five, then it is classified as a finance lease. Since both operating and finance leases are recorded on the Balance Sheet under ASC 842, the difference in classification primarily relates to the timing of the interest expense recognized on the lease. A popular practical expedient provided under ASC 842 allows companies to not readdress the lease classification of the lease upon transition to ASC 842.
IFRS 16 accounts for only one type of lease: finance leases. Unlike U.S. GAAP, there are no specific classification criteria since there is only one type of lease under IFRS 16.
𝟱: 𝗟𝗲𝗮𝘀𝗲 𝗟𝗶𝗮𝗯𝗶𝗹𝗶𝘁𝘆
Finally, under IFRS, lessees are required to remeasure their lease liability for any changes in future payments. Therefore, for leases with payments tied to an index, each time there is a change in the index, the Company will be required to remeasure the lease liability. For example, a lease that is based on CPI will require the lessee to remeasure the lease liability and ROU asset every time CPI is adjusted.
With U.S. GAAP, the lease liability is calculated based on the future fixed lease payments, plus any variable lease payments that are subject to an index or rate. The lease liability is calculated based on the index as of the measurement date, and then any fluctuations are recognized as variable payments in the current period. For example, if in year 2 of the lease, the lease payments increased by $50 because of a change in CPI, the lessee should recognize the additional $50 in current period profit/loss and not reassess the lease liability.
For companies that report in both U.S. GAAP and IFRS, this difference can be a time consuming, so it is important that a company select a software that can easily account for the leases under both US GAAP and IFRS concurrently.
Above we have highlighted a few of the key differences between the new lease standards under U.S. GAAP and IFRS. Because of these variations, many companies have difficulties reporting under both pieces of guidance. The key is finding the right software to assist with dual reporting.
The SAP Contract and Lease Management solution (based on SAP RE-FX component) is natively integrated with SAP Finance and is designed to support leasing and contract management processes. These processes include managing leasing terms, tracking payment types, renewal/termination options, reminders for critical dates, sales based rent calculations and common area maintenance expenses. The solution generates payment of invoices with real time integration with SAP Accounts Payable and Receivables. The solution also supports the new lease accounting standards (IFRS16 and ASC842) for both equipment and real estate asset classes. The lease accounting functionality found within SAP Contract and Lease Management calculates the right of use asset, liability, repayment of the liability and interest based on the liability balance. When generating postings, the solution creates the right of use asset, posts the liability, reduction of the liability and interest in real time and without the maintenance of external interfaces. As it is natively integrated with SAP Finance, it leverages configured accounting calendars, including fixed periods and non-calendar based fiscal years and different transition and migration scenarios. It also supports subleases (finance and operating leases out) and leases based on multi-currencies. This solution is available from ECC 6.0 EHP6, S/4HANA and S/4HANA Cloud. It is delivered via support packages and requires no additional hardware or software.