IFRS for SMEs — U.S. GAAP Comparison Wiki

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Leases

SME Par.IFRS SMEU.S. GAAP
Scope of this section
20.1 This section covers accounting for all leases other than:
  1. leases to explore for or use minerals, oil, natural gas and similar non-regenerative resources (see Section 34 Specialised Activities).
  2. licensing agreements for such items as motion picture films, video recordings, plays, manuscripts, patents and copyrights (see Section 18 Intangible Assets other than Goodwill).
  3. measurement of property held by lessees that is accounted for as investment property and measurement of investment property provided by lessors under operating leases (see Section 16 Investment Property).
  4. measurement of biological assets held by lessees under finance leases and biological assets provided by lessors under operating leases (see Section 34).
  5. leases that could lead to a loss to the lessor or the lessee as a result of contractual terms that are unrelated to changes in the price of the leased asset, changes in foreign exchange rates, or a default by one of the counterparties (see paragraph 12.3(f).
  6. operating leases that are onerous.
 Unlike IFRS SMEs, the U.S. GAAP lease accounting literature applies only to property, plant, and equipment (land and depreciable assets).
  1. Same.
  2. Same.
  3. Unlike IFRS SMEs, there is no concept of “investment property.”
  4. Like IFRS SMEs, leases concerning rights to exploit natural resources, such as timber, are specifically excluded from the scope of the authoritative literature on leases. Other biological assets, defined in IFRS SMEs as “a living animal or plant,” would be excluded from the scope of that literature because they do not meet the definition of property, plant, and equipment. Leases of some biological assets, however, might fall into the scope of the authoritative accounting literature on leases, unlike IFRS SMEs.
  5. See Section 12, Other Financial Instruments Issues, par. 12.4.
  6. Unlike IFRS SMEs, the authoritative accounting literature on leases does not exclude from its scope operating leases that are onerous.
20.2 This section 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. This section does not apply to agreements that are contracts for services that do not transfer the right to use assets from one contracting party to the other.  
20.3 Some arrangements, such as outsourcing arrangements, telecommunication contracts that provide rights to capacity, and take-or-pay contracts, do not take the legal form of a lease but convey rights to use assets in return for payments. Such arrangements are in substance leases of assets, and they should be accounted for under this section. Like IFRS SMEs, lease accounting applies to arrangements other than those in the legal form of a lease that convey the right to use specifically identified property, plant, and equipment if the definition of a lease is met.
Classification of leases
20.4 A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership. Same. However, U.S. GAAP contains more detailed requirements than IFRS SMEs. [Note: The IFRS SMEs term “finance lease” is equivalent to the U.S. GAAP term “capital lease.”]
20.5 Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract. Examples of situations that individually or in combination would normally lead to a lease being classified as a finance lease are:
  1. the lease transfers ownership of the asset to the lessee by the end of the lease term.
  2. the lessee has the option to purchase the asset at a price that is expected to be sufficiently lower than the fair value at the date the option becomes exercisable for it to be reasonably certain, at the inception of the lease, that the option will be exercised.
  3. the lease term is for the major part of the economic life of the asset even if title is not transferred.
  4. at the inception of the lease the present value of the minimum lease payments amounts to at least substantially all of the fair value of the leased asset.
  5. the leased assets are of such a specialised nature that only the lessee can use them without major modifications.
 The concepts for determining whether a lease is a capital lease to a lessee generally are the same as under IFRS SMEs. Unlike IFRS SMEs, however, U.S. GAAP provides specific quantitative thresholds for determining whether criteria (c) and (d) are met:
  • Criterion (c) is met if the lease term is equal to 75 percent or more of the estimated economic life of the leased property, except when the asset is in the last 25 percent of its economic life.
  • Criterion (d) is met if the present value of the minimum lease payments, excluding executory costs, equals or exceeds 90 percent of the fair value of the leased property less any investment tax credit retained by the lessor, except when the asset is in the last 25 percent of its economic life.
Unlike IFRS SMEs, except for leases of real estate that qualify as sales-type leases (see 20.20), there are two additional criteria that must be met for the lease to be accounted for by the lessor as a capital lease:
  1. Collectibility of the minimum lease payments is reasonably predictable.
  2. No important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor under the lease.
Unlike IFRS SMEs, a lessor must determine which of three types of capital lease an arrangement is: sales-type, direct financing, or leveraged.

Unlike IFRS SMEs, if land is the sole item of property leased, the lessee accounts for the lease as a capital lease only if the lease transfers ownership of the property at the end of the lease term or the lease contains a bargain purchase option. Otherwise, the lease is accounted for by the lessee as an operating lease.

Unlike IFRS SMEs, U.S. GAAP provides specific guidance on determining the lease term and on what is included in minimum lease payments.
20.6 Indicators of situations that individually or in combination could also lead to a lease being classified as a finance lease are:
  1. if the lessee can cancel the lease, the lessor’s losses associated with the cancellation are borne by the lessee.
  2. gains or losses from the fluctuation in the residual value of the leased asset accrue to the lessee (eg in the form of a rent rebate equalling most of the sales proceeds at the end of the lease).
  3. the lessee has the ability to continue the lease for a secondary period at a rent that is substantially lower than market rent.
 Unlike IFRS SMEs, U.S. GAAP includes no additional indicators that a lease may be a capital lease.
20.7 The examples and indicators in paragraphs 20.5 and 20.6 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. For example, this may be the case if ownership of the asset is transferred to the lessee at the end of the lease for a variable payment equal to the asset’s then fair value, or if there are contingent rents, as a result of which the lessee does not have substantially all risks and rewards incidental to ownership. Under U.S. GAAP, if a lease meets the specified criteria for classification as a capital lease, it is classified as a capital lease; otherwise it is classified as an operating lease.
20.8 Lease classification is made at the inception of the lease and is not changed during the term of the lease unless the lessee and the lessor agree to change the provisions of the lease (other than simply by renewing the lease), in which case the lease classification shall be re-evaluated. Same, except that U.S. GAAP states explicitly that a renewal or extension of the lease pursuant to terms in the original agreement is treated as a new lease unless the renewal or extension was included in the original lease term (e.g., a bargain renewal option).
Financial statements of lessees—finance leases
 Initial recognition
20.9 At the commencement of the lease term, a lessee shall recognise its rights of use and obligations under finance leases as assets and liabilities in its statement of financial position at amounts equal to the fair value of the leased property or, if lower, the present value of the minimum lease payments, determined at the inception of the lease. Any initial direct costs of the lessee (incremental costs that are directly attributable to negotiating and arranging a lease) are added to the amount recognised as an asset. Same, except that, unlike IFRS SMEs, initial direct costs incurred by the lessee are charged to expense as incurred.
20.10 The present value of the minimum lease payments should be calculated using the interest rate implicit in the lease. If this cannot be determined, the lessee’s incremental borrowing rate shall be used.

[IFRS SMEs defines “interest rate implicit in the lease” as follows: The discount rate that, at the inception of the lease, causes the aggregate present value of (a) the minimum lease payments and (b) the unguaranteed residual value to be equal to the sum of (i) the fair value of the leased asset and (ii) any initial direct costs of the lessor.]		 Unlike IFRS SMEs, a lessee calculates the present value of minimum lease payments using the lower of the interest rate implicit in the lease, if it is practicable for the lessee to learn the rate computed by the lessor, or the lessee’s incremental borrowing rate.

Unlike IFRS SMEs, the interest rate implicit in the lease (a) considers any investment tax credits retained by the lessor and (b) does not consider any initial direct costs of the lessor.
 Subsequent measurement
20.11 A lessee shall apportion minimum lease payments between the finance charge and the reduction of the outstanding liability using the effective interest method (see paragraphs 11.15–11.20). The lessee shall allocate the finance charge to each period during the lease term so as to produce a constant periodic rate of interest on the remaining balance of the liability. A lessee shall charge contingent rents as expenses in the periods in which they are incurred. Same. However, contingent rents are recognized as rental expense under U.S. GAAP when achievement of the specified target that triggers the contingent rents is considered probable; it is unclear when contingent rents are incurred under IFRS SMEs.
20.12 A lessee shall depreciate an asset leased under a finance lease in accordance with the relevant section of this IFRS for that type of asset, eg Section 17 Property, Plant and Equipment, Section 18 or Section 19 Business Combinations and Goodwill. If there is no reasonable certainty that the lessee will obtain ownership by the end of the lease term, the asset shall be fully depreciated over the shorter of the lease term and its useful life. A lessee shall also assess at each reporting date whether an asset leased under a finance lease is impaired (see Section 27 Impairment of Assets). Although under U.S. GAAP the amortization period is linked to the specific criterion under which the lease qualified as a capital lease, one would expect the amortization periods under IFRS SMEs and U.S. GAAP to be the same in practice. Unlike IFRS SMEs, however, assets with finite useful lives, including capital leases of lessees, are tested for impairment only if there is an indicator of impairment.
Financial statements of lessees—operating leases
 Recognition and measurement
20.15 A lessee shall recognise lease payments under operating leases (excluding costs for services such as insurance and maintenance) as an expense on a straight-line basis unless either
  1. another systematic basis is representative of the time pattern of the user’s benefit, even if the payments are not on that basis, or
  2. the payments to the lessor are structured to increase in line with expected general inflation (based on published indexes or statistics) to compensate for the lessor’s expected inflationary cost increases. If payments to the lessor vary because of factors other than general inflation, then this condition (b) is not met.
Example of applying paragraph 20.15(b):
X operates in a jurisdiction in which the consensus forecast by local banks is that the general price level index, as published by the government, will increase by an average of 10 per cent annually over the next five years. X leases some office space from Y for five years under an operating lease. The lease payments are structured to reflect the expected 10 per cent annual general inflation over the five-year term of the lease as follows

Year 1: CU100,000
Year 2: CU110,000
Year 3: CU121,000
Year 4: CU133,000
Year 5: CU146,000

X recognises annual rent expense equal to the amounts owed to the lessor as shown above. If the escalating payments are not clearly structured to compensate the lessor for expected inflationary cost increases based on published indexes or statistics, then X recognises annual rent expense on a straight-line basis: CU122,000 each year (sum of the amounts payable under the lease divided by five years).		 Like IFRS SMEs, a lessee under an operating lease recognizes rent expense on a straight-line basis over the lease term unless another systematic and rational allocation basis is more representative of the time pattern in which the leased property is physically employed. Unlike IFRS SMEs, however, there is no exception to this rule for scheduled rent increases to reflect the anticipated effects of inflation.
Financial statements of lessors: finance leases
 Initial recognition and measurement
20.17 A lessor shall recognise assets held under a finance lease in their statements of financial position and present them as a receivable at an amount equal to the net investment in the lease. The net investment in a lease is the lessor’s gross investment in the lease discounted at the interest rate implicit in the lease. The gross investment in the lease is the aggregate of:
  1. the minimum lease payments receivable by the lessor under a finance lease, and
  2. any unguaranteed residual value accruing to the lessor.
 Unlike IFRS SMEs, recognition of assets under a capital lease depends on the classification of the lease as either a sales-type, direct-financing, or leveraged lease. See 20.20-20.22 regarding sales-type leases. IFRS SMEs contains no equivalent of a leveraged lease. (A leveraged lease is a type of direct-financing lease in which the lessor finances a substantial portion of its net investment in the lease on a nonrecourse basis with a long-term creditor, and the lessor’s net investment in the lease declines and rises during the lease term.)

Initial recognition and measurement of direct-financing leases is the same as under IFRS SMEs. For leveraged leases, however, the net investment in the lease includes any investment tax credit and is recorded net of the nonrecourse debt, unlike IFRS SMEs.
20.18 For finance leases other than those involving manufacturer or dealer lessors, initial direct costs (costs that are incremental and directly attributable to negotiating and arranging a lease) are included in the initial measurement of the finance lease receivable and reduce the amount of income recognised over the lease term. Same.
 Subsequent measurement
20.19 The recognition of finance income shall be based on a pattern reflecting a constant periodic rate of return on the lessor’s net investment in the finance lease. Lease payments relating to the period, excluding costs for services, are applied against the gross investment in the lease to reduce both the principal and the unearned finance income. If there is an indication that the estimated unguaranteed residual value used in computing the lessor’s gross investment in the lease has changed significantly, the income allocation over the lease term is revised, and any reduction in respect of amounts accrued is recognised immediately in profit or loss. Same, except that, unlike IFRS SMEs—
  • Unguaranteed residual values must be reviewed at least annually; no upward adjustment of the estimated residual value may be made.
  • For leveraged leases, income is recognized at a constant periodic rate of return based on after-tax cash flows in the periods during which there is a positive net investment in the lease.
 Manufacturer or dealer lessors
20.20 Manufacturers or dealers often offer to customers the choice of either buying or leasing an asset. A finance lease of an asset by a manufacturer or dealer lessor gives rise to two types of income:
  1. profit or loss equivalent to the profit or loss resulting from an outright sale of the asset being leased, at normal selling prices, reflecting any applicable volume or trade discounts, and
  2. finance income over the lease term.
 The guidance in IFRS SMEs on accounting by manufacturer or dealer lessors generally corresponds to accounting for a sales-type lease under U.S. GAAP. But a lessor need not be a manufacturer or dealer for the lease to qualify as a sales-type lease. Sales-type leases are defined as leases in which the asset, at the inception of the lease, has a fair value that is greater or less than its cost or carrying amount, if different. Furthermore, leases involving real estate are classified as sales-type leases only if the lease transfers ownership of the leased property to the lessee by the end of the lease term.
20.21 The sales revenue recognised at the commencement of the lease term by a manufacturer or dealer lessor is the fair value of the asset or, if lower, the present value of the minimum lease payments accruing to the lessor, computed at a market rate of interest. The cost of sale recognised at the commencement of the lease term is the cost, or carrying amount if different, of the leased property less the present value of the unguaranteed residual value. The difference between the sales revenue and the cost of sale is the selling profit, which is recognised in accordance with the entity’s policy for outright sales. Same.
20.22 If artificially low rates of interest are quoted, selling profit shall be restricted to that which would apply if a market rate of interest were charged. Costs incurred by manufacturer or dealer lessors in connection with negotiating and arranging a lease shall be recognised as an expense when the selling profit is recognised. Unlike IFRS SMEs, there is no adjustment to the sale price to reflect a market rate of interest.
Financial statements of lessors: operating leases
 Recognition and measurement
20.24 A lessor shall present assets subject to operating leases in its statement of financial position according to the nature of the asset. Same.
20.25 A lessor shall recognise lease income from operating leases (excluding amounts for services such as insurance and maintenance) in profit or loss on a straight-line basis over the lease term, unless either
  1. another systematic basis is representative of the time pattern of the lessee’s benefit from the leased asset, even if the receipt of payments is not on that basis, or
  2. the payments to the lessor are structured to increase in line with expected general inflation (based on published indexes or statistics) to compensate for the lessor’s expected inflationary cost increases. If payments to the lessor vary according to factors other than inflation, then condition (b) is not met.
 Like IFRS SMEs, a lessor under an operating lease recognizes rent income on a straight-line basis over the lease term unless another systematic and rational allocation basis is more representative of the time pattern in which use benefit from the leased property is diminshed. Unlike IFRS SMEs, however, there is no exception to this rule for scheduled rent increases to reflect the anticipated effects of inflation.
20.26 A lessor shall recognise as an expense costs, including depreciation, incurred in earning the lease income. The depreciation policy for depreciable leased assets shall be consistent with the lessor’s normal depreciation policy for similar assets. Same.
20.27 A lessor shall add to the carrying amount of the leased asset any initial direct costs it incurs in negotiating and arranging an operating lease and shall recognise such costs as an expense over the lease term on the same basis as the lease income. Like IFRS SMEs, initial direct costs of the lessor are recognized as an expense over the lease term. Unlike IFRS SMEs, however, they not added to the carrying amount of the leased asset; they are presented separately and allocated to expense in proportion to the recognition of rental income.
20.28 To determine whether a leased asset has become impaired, a lessor shall apply Section 27. Like IFRS SMEs, long-lived assets of lessors subject to operating leases are within the scope of the authoritative literature on accounting for impairment of long-lived assets.
20.29 A manufacturer or dealer lessor does not recognise any selling profit on entering into an operating lease because it is not the equivalent of a sale. Same.
Sale and leaseback transactions
20.32 A sale and leaseback transaction involves the sale of an asset and the leasing back of the same asset. The lease payment and the sale price are usually interdependent because they are negotiated as a package. The accounting treatment of a sale and leaseback transaction depends on the type of lease.  
 Sale and leaseback transaction results in a finance lease
20.33 If a sale and leaseback transaction results in a finance lease, the seller-lessee shall not recognise immediately, as income, any excess of sales proceeds over the carrying amount. Instead, the seller-lessee shall defer such excess and amortise it over the lease term. Unlike IFRS SMEs, U.S. GAAP specifies that profit or loss on the sale must be amortized in proportion to the amortization of the leased asset.
 Sale and leaseback transaction results in an operating lease
20.34 If a sale and leaseback transaction results in an operating lease, and it is clear that the transaction is established at fair value, the seller-lessee shall recognise any profit or loss immediately. If the sale price is below fair value, the seller-lessee shall recognise any profit or loss immediately unless the loss is compensated for by future lease payments at below market price. In that case the seller-lessee shall defer and amortise such loss in proportion to the lease payments over the period for which the asset is expected to be used. If the sale price is above fair value, the seller-lessee shall defer the excess over fair value and amortise it over the period for which the asset is expected to be used. Unlike IFRS SMEs, immediate gain recognition is not permitted if the leaseback is classified as an operating lease, unless the leaseback is minor. Generally, any gain or loss on the sale is deferred and amortized in proportion to rental expense. Also unlike IFRS SMEs, if the fair value of the property at the time of the transaction is less than its undepreciated cost, a loss is recognized immediately up to the amount of the difference between undepreciated cost and fair value.
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