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Leases: Key differences between U.S. GAAP and IFRSs

Under U.S. GAAP, ASC 840 is the primary source of guidance on a lessor's and lessee's accounting for leases.

Under IFRSs, IAS 17, Leases, is the primary source of guidance on lessor and lessee accounting as well as on sale-and-leaseback transactions. In addition, see the guidance in IFRIC 4, Determining Whether an Arrangement Contains a Lease.

The table below summarizes these differences and is followed by a detailed explanation of each difference.1

SubjectU.S. GAAPIFRSs

Scope

Only leases involving property, plant, and equipment.

Scope broadly applies to assets (with certain exceptions).

Lease classification

The classification of a lease depends on whether the lease meets certain criteria.

The classification of a lease depends on the substance of the transaction. Specific indicators and examples are provided.

Lessor accounting — sales-type leases

Specific criteria are provided for sales-type leases.

No specific criteria are provided for sales-type leases.

Leases of land and buildings

Land and building elements are generally accounted for as a single unit unless land represents more than 25 percent of the total fair value of the leased property.

Land and building elements are assessed separately for classification as a finance or operating lease.

Present value of minimum lease payments

A lessee uses the rate implicit in the lease to discount minimum lease payments if this rate is known and lower than the incremental borrowing rate.

A lessee generally uses the rate implicit in the lease to discount minimum lease payments.

Leveraged leases

Special accounting is permitted for leveraged leases if specific criteria are met.

No special accounting provided for leveraged leases.

Recognition of a gain or loss on a sale-and-leaseback transaction

If the seller does not relinquish more than a minor part of the right to use the asset, a gain or loss is generally deferred and amortized over the lease term for an operating lease and over the useful life for a capital lease. If the seller relinquishes more than a minor part of the use of the asset, part or all of a gain may be recognized, depending on the amount relinquished.

If the leaseback is a finance lease, the gain or loss is recognized over the lease term.

If the leaseback is an operating lease, the recognition of a gain or loss differs depending on whether the transaction is established at, below, or above fair value.

Sale-and-leaseback transactions involving real estate

There are specific requirements for sale-and-leaseback transactions involving real estate.

The accounting for sale-and-leaseback transactions involving real estate is no different from that for sale-and-leaseback transactions involving non-real-estate assets.

Scope

Under U.S. GAAP, ASC 840 defines a lease as "an agreement conveying the right to use property, plant, or equipment (land and/or depreciable assets) usually for a stated period of time."

Under IFRSs, IAS 17 applies to "agreements that transfer the right to use assets even though substantial services by the lessor may be called for in connection with the operation or maintenance of such assets." Therefore, the scope of IAS 17 includes the right to use other assets in addition to property, plant, and equipment (e.g., certain intangible assets). Intangible assets are within the scope of IAS 17 if rights are established for the exclusive use of such assets. For example, brands and trademarks often are licensed exclusively and therefore are intangible assets that are within the scope of IAS 17.

Lease Classification

Under U.S. GAAP, the classification of leases (e.g., operating, capital) depends on whether the lease meets certain criteria. ASC 840-10-25-1 indicates that a lessee classifies a lease as a capital lease if it meets one or more of the following criteria:

  • "The lease transfers ownership of the property to the lessee by the end of the lease term."
  • "The lease contains a bargain purchase option."
  • "The lease term [is at least] 75 percent . . . of the estimated economic life of the leased property. However, if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property, including earlier years of use, this criterion shall not be used for purposes of classifying the lease."
  • "The present value . . . of the minimum lease payments [at lease inception] excluding . . . executory costs [is at least] 90 percent of the excess of the fair value of the leased property. If the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property, including earlier years of use, this criterion shall not be used for purposes of classifying the lease."

If none of these criteria are met, the lease is classified as an operating lease.

ASC 840-10-25-42 states that a lessor would classify a lease as a sales-type, direct financing, or leveraged lease if, in addition to meeting any of the criteria described above, the lease meets both of the following conditions:

  • "Collectibility of . . . lease payments is reasonably predictable."
  • "No important uncertainties [exist regarding] the amount of unreimbursable costs yet to be incurred."

Under IFRSs, the classification of a lease does not depend on whether specified criteria are met. Rather, the classification depends on whether the lease is in substance an operating or finance lease (a capital lease in U.S.-GAAP-equivalent terminology). To assist in this determination, paragraphs 10 and 11 of IAS 17 provide the following examples and indicators that may lead to classification of a lease as a finance lease:

  • "The lease transfers ownership of the asset to the lessee by the end of the lease term."
  • The lease contains a bargain purchase option.
  • "The lease term is for the major part of the economic life of the asset even if title is not transferred."
  • The present value of the minimum lease payments at lease inception is for "substantially all of the fair value of the leased asset."
  • "The leased assets are of such a specialized nature that only the lessee can use them without major modifications."
  • "If the lessee can cancel the lease, the lessor's losses associated with the cancellation are borne by the lessee."
  • "Gains or losses from the fluctuation in the fair value of the residual accrue to the lessee (for example, in the form of a rent rebate equaling most of the sales proceeds at the end of the lease)."
  • "The lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent."

However, the above indicators may not always be determinative of a lease's classification. Paragraph 12 of IAS 17 states, in part:

The examples and indicators in paragraphs 10 and 11 are not always conclusive. If it is clear from other features that the lease does not transfer substantially all risks and rewards incidental to ownership, the lease is classified as an operating lease.

Lessor Accounting — Sales-Type Leases

Under U.S. GAAP, a sales-type lease is distinguished from a direct financing and leveraged lease on the basis of whether the lease gives rise to manufacturer or dealer profit (or loss) to the lessor (i.e., the fair value of the leased property at inception of the lease is greater or less than its cost or carrying amount, if different). Except for leases involving real estate, the lease also must meet one or more of the criteria in ASC 840-10-25-1 and both of the criteria in ASC 840-10-25-42. A lease of real estate should be classified as a sales-type lease only if the lessor transfers ownership of the real estate to the lessee by the end of the lease term.

IFRSs do not distinguish between sales-type leases and other types of finance leases. However, paragraphs 42–46 of IAS 17 discuss the accounting for finance leases that give rise to a manufacturer or dealer lessor's profit or loss.

Leases of Land and Buildings

Under U.S. GAAP, ASC 840-10-25-38 requires that a lease of land and building elements be accounted for as a single unit except when:

  • The lease transfers ownership at the end of the lease.
  • The lease contains a bargain purchase option.
  • The fair value of the land is at least 25 percent of the total fair value of the leased property at inception of the lease.

If the lease qualifies for either exception 1 or exception 2 above, the present value of the minimum lease payments is allocated between the land and building elements in proportion to their relative fair values at the inception of the lease. However, if the lease qualifies for exception 3, the land element's minimum lease payments are determined by applying the lessee's incremental borrowing rate to the fair value of the land; the remaining minimum lease payments are attributed to the building element.

Under IFRSs, paragraph 15A of IAS 17 states:

When a lease includes both land and buildings elements, an entity assesses the classification of each element as a finance or an operating lease separately in accordance with paragraphs 7–13. In determining whether the land element is an operating or a finance lease, an important consideration is that land normally has an indefinite economic life.

Further, paragraph 16 of IAS 17 states:

[T]he minimum lease payments (including any lump-sum upfront payments) are allocated between the land and the buildings elements in proportion to the relative fair values of the leasehold interests in the land element and buildings element of the lease at the inception of the lease. If the lease payments cannot be allocated reliably between these two elements, the entire lease is classified as a finance lease, unless it is clear that both elements are operating leases, in which case the entire lease is classified as an operating lease.

Present Value of Minimum Lease Payments

Under U.S. GAAP, lessees use the incremental borrowing rate to calculate the minimum lease payments unless the implicit rate is known and is lower. ASC 840-10-25-31 states, in part:

A lessee shall compute the present value of the minimum lease payments using the lessee's incremental borrowing rate unless both of the following conditions are met, in which circumstance the lessee shall use the implicit rate:
a. It is practicable for the lessee to learn the implicit rate computed by the lessor.
b. The implicit rate computed by the lessor is less than the lessee's incremental borrowing rate.

Under IFRSs, lessees generally would use the rate implicit in the lease to discount minimum lease payments. Paragraph 20 of IAS 17 states, in part:

The discount rate to be used in calculating the present value of the minimum lease payments is the interest rate implicit in the lease, if this is practicable to determine; if not, the lessee's incremental borrowing rate shall be used.

Leveraged Leases

Under U.S. GAAP, ASC 840 provides specific criteria that must be met before a leveraged lease can be recorded as well as criteria related to the resulting accounting for a leveraged lease. ASC 840-10-25-43 states, in part:

A lease is a leveraged lease if it has all of the following characteristics:
1. It meets the criteria in (b)(1) and (b)(2) for a direct financing lease.
2. It involves at least three parties: a lessee, a long-term creditor, and a lessor (commonly called the equity participant).
3. The financing provided by the long-term creditor is nonrecourse as to the general credit of the lessor (although the creditor may have recourse to the specific property leased and the unremitted rentals relating to it). The amount of the financing is sufficient to provide the lessor with substantial leverage in the transaction.
4. The lessor's net investment (see paragraph 840-30-25-8) declines during the early years once the investment has been completed and rises during the later years of the lease before its final elimination. Such decreases and increases in the net investment balance may occur more than once.

Under IFRSs, no special accounting is provided for leveraged leases. All leases are accounted for as either operating leases or finance leases.

Recognition of a Gain or Loss on a Sale-and-Leaseback Transaction

Under both U.S. GAAP and IFRSs, the recognition of a gain or loss on a sale-and-leaseback transaction differs depending on the classification of the leaseback.

Leaseback Is a Capital (Finance) Lease2

Under U.S. GAAP, ASC 840-40-25-3 indicates that any profit or loss resulting from a sale-and-leaseback transaction in which the leaseback is a capital lease is deferred and amortized in proportion to the amortization of the leased asset3 unless any of the following conditions exist:

  • The seller retains only a "minor portion" of the remaining use of the property.
  • The seller retains "more than a minor part but less than substantially all" of the remaining use of the property.
  • “The fair value of the property at the time of the transaction is less than its undepreciated cost, in which circumstance a loss shall be recognized immediately.”

If the seller retains only a minor portion of the remaining use of the property, the sale and leaseback should be accounted for as separate transactions on the basis of their respective terms. If the seller retains "more than a minor part but less than substantially all" of the remaining use of the property, the profit on the sale in excess of the recorded amount of the leased asset is recognized as of the date of sale.

While ASC 840 does not define the terms "minor" or "substantially all" in the context of the seller's remaining use of the property in a sale-and-leaseback transaction, it indicates that 10 percent of the remaining use of the asset can be presumed to be "minor." Consequently, "substantially all" of the remaining use of the asset in this context can be presumed to be 90 percent.

Under IFRSs, a gain resulting from a sale-and-leaseback transaction in which the leaseback is a finance lease is deferred and amortized over the lease term. Paragraph 59 of IAS 17 states:

If a sale and leaseback transaction results in a finance lease, any excess of sales proceeds over the carrying amount shall not be immediately recognised as income by a seller-lessee. Instead, it shall be deferred and amortised over the lease term.

Leaseback Is an Operating Lease

Under U.S. GAAP, ASC 840-40-25-3 indicates that any profit or loss resulting from a sale-and-leaseback transaction in which the resulting lease is an operating lease is deferred and amortized in proportion to the related gross rental charged to expense over the lease term4 unless any of the following conditions are met:

  • The seller retains only a "minor portion" of the remaining use of the property.
  • The seller retains "more than a minor part but less than substantially all" of the remaining use of the property.
  • “The fair value of the property at the time of the transaction is less than its undepreciated cost, in which circumstance a loss shall be recognized immediately.”

If the seller retains only a minor portion of the remaining use of the property, the sale and leaseback should be accounted for as separate transactions on the basis of their respective terms. If the seller retains "more than a minor part but less than substantially all" of the remaining use of the property, the profit on the sale in excess of the present value of minimum lease payments is recognized as of the date of sale.

Under IFRSs, the recognition of a gain resulting from a sale-and-leaseback transaction in which the leaseback is an operating lease differs depending on whether the transaction is established at fair value. Paragraph 61 of IAS 17 states that the profit or loss resulting from a sale-and-leaseback transaction should be accounted as follows:

  • If the sales price is established at fair value, the profit or loss should be recorded immediately.
  • If the sales price is below fair value, the profit or loss is recorded immediately unless "the loss is compensated by future lease payments," in which case the loss is "deferred and amortised in proportion to the lease payments over the period" of expected use.
  • "If the sale[s] price is above fair value, the excess over fair value shall be deferred and amortised" over the asset's period of expected usage.

Sale-and-Leaseback Transactions Involving Real Estate

Under U.S. GAAP, there are separate requirements for sale-and-leaseback transactions involving real estate. ASC 840-40 contains criteria that must be met for the sale-and-leaseback transaction to be accounted for as a sale of real estate.

Under IFRSs, the accounting for sale-and-leaseback transactions involving real estate is no different from that for sale-and-leaseback transactions involving non-real-estate assets.

____________________

1 Differences are based on comparison of authoritative literature under U.S. GAAP and IFRSs and do not necessarily include interpretations of such literature.

2 A finance lease under IFRSs would be considered the same as a capital lease under U.S. GAAP.

3 If the leased asset is land only, the deferred profit or loss must be amortized on a straight-line basis over the lease term.

4 See footnote 2.

Correction list for hyphenation

These words serve as exceptions. Once entered, they are only hyphenated at the specified hyphenation points. Each word should be on a separate line.