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The new lease accounting standards, IFRS 16 and ASC 842, primarily retain the lessor accounting guidance under the previous standards, i.e. requirement to classify the leases into finance and operating leases based on whether risks and rewards inherent in the leased asset are transferred.
Under IFRS, a lessor classifies each lease as either a finance lease or an operating lease.
In a finance lease, a lessor derecognizes the leased asset and recognizes a lease asset (lease receivable plus residual). If the lessor is also a manufacturer or dealer, it recognizes revenue equal to the leased asset, cost of goods sold equal to the carrying amount of the leased asset and associated profit or loss. Subsequent to initial recognition, a lessor recognizes finance income on a finance lease and reduces lease receivable by the difference between lease receipts and interest income.
In an operating lease, subsequent to initial recognition, a lessor recognizes rental income and associated depreciation expense. On the cash flow statement, the interest portion of lease receipt is recognized either as operating or investing activity while lease principal inflow is categorized as investing.
Under US GAAP, a lessor classifies a lease as either sale-type, operating or direct financing.
A lease is classified as a sales-type lease when the lease meets the ownership-transfer criteria and it is recognized by derecognition of assets, recognition of revenue, cost of goods sold and lease receivable. However, if the criteria for a sales-type lease are not met or collection of the lease payment is not probable, the lease is recognized either as operating or direct-financing.
A lease is classified as direct financing, if sales-type lease criteria is not met, but the lessor expects to recover the asset’s cost through lease receipts. It is a lease which effectively converts the lessor’s risk arising from ownership of the asset to credit risk.
In an operating lease, a lessor recognizes lease receipts as income and records associated expenses such as depreciation. On a statement of cash flows, interest income is classified as operating and principal receipts are classified as investing.
Even though differences between IFRS and US GAAP in lessor accounting are less pronounced than differences in lessee accounting, an analyst needs to be aware of the differences and adjust where required. In contrast with US GAAP, due to non-existence of sales-type classification, IFRS requires recognition of initial selling profit on all non-operating leases at inception.
by Obaidullah Jan, ACA, CFA on Sat Apr 25 2020
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