Differences Between FASB ASC Topic 842 and IFRS 16 for Lessees

The FASB and the IASB issued their respective lease accounting standards in early 2016 as part of a joint project between both standard-setting bodies.  Despite the joint project initiative, the FASB and the IASB diverged on key accounting issues for leases. 

Dual reporters and those transitioning to or from IFRS 16 to FASB ASC Topic 842 should be aware of the key differences between the two lease standards including the difference in lease classification, discount rate definitions, lease payments that depend on an index or rate, and the low-value lease exemption.

The single lease accounting model referred to in the IFRS 16 guidelines means that there is not a distinction between operating leases and finance leases, whereas FASB ASC Topic 842 retains the distinction between operating and finance leases.  The classification analysis under FASB ASC Topic 842 is similar to the current capital-lease-versus-operating-lease test under FASB ASC Topic 840, but the FASB ASC Topic 842 classification tests do not contain bright-line thresholds.  Those with dual reporting requirements might be wondering what the difference is between operating leases and finance leases under FASB ASC Topic 842, since leases are reported on the balance sheet regardless of classification. The key distinction is in the expense recognition during the subsequent accounting.  Operating leases under FASB ASC Topic 842 will recognize a straight-line lease expense, whereas FASB ASC Topic 842 finance leases recognize amortization and interest expense.  This results in accelerated expense recognition in the earlier period of a finance lease compared to an operating lease.  The recognition and initial and subsequent measurement of a finance lease under FASB ASC Topic 842 are the same under IFRS 16.

The discount rate is used to calculate the present value of the lease liability in FASB ASC Topic 842 and IFRS 16 and should ideally reflect how the contract is priced.  If it is readily determinable, the rate implicit in the lease contract should be used to discount the lease liability.  If the implicit interest rate cannot be readily determined, a lessee is permitted to use its incremental borrowing rate.  There are conceptual differences in the definition of the incremental borrowing rate within IFRS 16 compared to FASB ASC Topic 842.  Under IFRS 16, the incremental borrowing rate is the rate of interest that a lessee would have to pay in order to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.  The FASB ASC Topic 842 definition of incremental borrowing rate is less prescriptive than the IFRS 16 definition.  It is defined as the rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term, an amount equal to the lease payments in a similar economic environment.  FASB ASC Topic 842 also includes an optional accounting policy election for nonpublic entities to use a risk-free discount rate in lieu of an incremental borrowing rate, whereas IFRS 16 is silent to any such accounting policy election for nonpublic entities.  Depending on the sophistication and resources of an entity’s treasury management function, it may be appropriate and necessary to select an incremental borrowing rate(s) from published sources, seek rate quotes from lenders, and perform sensitivity analyses over the rate(s).

Lease payments that depend on an index or rate are measured based on the index or rate on the lease commencement date and are not remeasured in each subsequent year according to the guidelines of FASB ASC Topic 842, whereas under IFRS 16, lease payments that depend on an index or rate are remeasured annually to reflect the most current index or rate.  

IFRS 16 contains similar exemptions and practical expedients to FASB ASC Topic 842, including the package of three transitional practical expedients, the hindsight practical expedient, the short-term lease exemption, the practical expedient to not separate lease and non-lease components, and the portfolio approach practical expedient.  IFRS 16 includes a low-value lease exemption not contained in FASB ASC Topic 842.  The low-value threshold is not explicitly defined in the IFRS 16 standard, although in the Basis for Conclusions contained within IFRS 16, the Board quotes $5,000 as a possible threshold.  Many organizations have elected to utilize their capitalization threshold to identify low-value leases, which we believe is an appropriate accounting policy.

Organizations need to find a suitable solution for calculating the FASB ASC Topic 842 right-of-use assets and lease liabilities at the transition date and the subsequent lease accounting.  Generally, an Excel-based solution would be appropriate for a noncomplex portfolio of 10 or fewer leases. If the lease profile is more complex or greater than 10 individual leases, management is better served by a lease software solution, such as simpLEASE. In addition to offering our clients simpLEASE, Schneider Downs provides advisory services for the technical aspects of lease accounting. For more information concerning lease accounting and the impact on your organization, please visit the Schneider Downs Our Thoughts On blog or email us at [email protected].