IFRS 16 vs ASC 842: What are the Differences?

ASC 842 and IFRS 16 are some of the biggest changes in lease accounting in the past 30+ years. In this blog, we discuss the differences between the two and what those differences mean for you and your organization.

Let’s start with some definitions.

What is ASC 842?

ASC 842 is one of the most important lease accounting standards in the US. It requires all leases to be recorded as assets and liabilities on an organization’s balance sheet.

All organizations that follow generally accepted accounting principles (GAAP) and lease assets from other organizations are called lessees, and therefore are required to classify leases as either finance or operating leases. Organizations leasing assets to others are called lessors, and record leases as either sales-type, direct financing, or operating leases.

What is IFRS 16?

The IFRS 16 standard requires lessees to recognize most leases on the balance sheet in the form of assets and liabilities. Lessors classify leases as either finance leases or operating leases and account for them accordingly.

What are the Major Differences Between ASC 842 and IFRS 16?

How do IFRS 16 and ASC 842 differ in the classification of leases?

Under IFRS 16, lessees classify leases as finance leases, as the IASB eliminated the concept of the operating lease for lessees. Lessors record leases as either a finance lease or operating lease.

In the US, where ASC 842 is applied, lessees classify their leases as either operating or finance. Lessors record leases as sales-type, direct financing, or operating leases.

Under ASC 842, lessees have the option of including leases shorter than 12 months in their reporting, while IFRS 16 excludes all leases shorter than 12 months.

What impact do IFRS 16 and ASC 842 have on a company's balance sheet?

Both standards require lessees to record leases on their balance sheet, providing investors and users of financial statements a basis to understand the effect of liabilities related to leases. Before ASC 842, operating leases did not have to be recorded on a company’s balance sheet in the form of ROU Assets and Lease Liability.

What are the differences in disclosure requirements between IFRS 16 and ASC 842?

Both IFRS 16 and ASC 842 have qualitative and quantitative disclosure requirements for lessees.

IFRS 16 quantitative disclosure requirements include:

• ​Interest expense on lease liabilities
• ​Expenses relating to short-term leases
• ​Expenses related to leases of low-value assets
• ​Expenses related to variable lease payments not included in the measurement of the lease liabilities
• ​Income from subleasing ROU assets
• ​The total cash outflow for leases
• ​Additions to ROU assets
• ​Gains or losses arising from sale-and-leaseback transactions
• ​The carrying amount of ROU assets at the end of the reporting period by class of underlying asset
• ​Depreciation charge for ROU assets by the class of underlying asset

The qualitative disclosures for IFRS 16 leases include:

• ​The nature of the lessee’s leasing activities
• ​Future cash outflows to which the lessee could be exposed that are not reflected in the measurement of the lease liabilities
• ​Restrictions imposed by leases
• ​Sale and leaseback transactions

How do IFRS 16 and ASC 842 differ in terms of recognizing right-of-use (ROU) assets and lease liabilities?

Under IFRS 16, a lessee has to recognize its right-of-use asset as well as any lease liability that represents its obligation to make its lease payments.

Under ASC 842, a lessee has to classify a lease as either finance or operating and record lease liabilities as well as right-of-use assets separately from each other and from other assets and liabilities on their balance sheet.

What are the differences in the treatment of short-term leases under IFRS 16 and ASC 842?

Under both IFRS 16 and ASC 842, leases shorter than 12 months are not required to be recorded on the balance sheet.

Under ASC 842, lessees may make a policy election to exclude leases of 12 months or less from being recorded on the balance sheet.

How do IFRS 16 and ASC 842 approach variable lease payments?

Examples of variable lease payments under ASC 842 and IFRS 16 are available in referenced guidance. Generally, both standards provide guidance on how to account for variable lease payments.

How do the transition methods for adopting IFRS 16 differ from those for ASC 842?

For IFRS 16, an entity does not need to reassess whether a contract is or contains a lease. As a practical expedient, an entity can apply this standard to contracts as they were previously identified, and can choose not to apply the standard to contracts that were not previously identified as a lease. Lessees can apply this standard retrospectively to each prior reporting period or retrospectively with the cumulative effect recorded.

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FAQs

How do IFRS 16 and ASC 842 handle lease modifications?

ASC 842 requires lessees to identify whether the lease modification grants additional right-to-use at standalone pricing. If it does, then the modification is recorded as a new lease. If it does not, then the original lease is modified. Depending on the type of change, the discount rate, payments, and classification may need to be updated.

Similar to ASC 842, IFRS 16 requires lessees to treat a modification as a separate lease if both the modification adds the right-to-use one or more assets and the payments increase based on standalone pricing. If it does not, the original lease is modified to remeasure the Lease Liability and ROU Asset.

What are the implications of IFRS 16 and ASC 842 on financial ratios and performance metrics?

Both IFRS 16 and ASC 842 increase current and long term lease liabilities and increase long term assets in the form of ROU Assets. These changes affect several ratios, including return on assets and the current ratio. Increasing debt in the form of lease liabilities can also affect debt covenant considerations.

Does IFRS 16 apply to US companies?

Yes, IFRS 16 applies to US companies. However, unlike ASC 842, the scope of application of IFRS 16 is international instead of restricted to just the US.