Lease accounting has received a significant refresh through the issuance of new IFRS and US GAAP leasing standards. Earlier standards allowed an ‘off-balance sheet’ leasing structure in which companies were not required to recognize assets and liabilities in case of operating leases.
Initial recognition
Under the new standards under both IFRS and US GAAP, a lessee must recognize an asset and a liability at inception for all its leases (except for short-term leases). The lessee reports a ‘right-of-use’ asset and a lease liability equal to the present value of fixed lease payments.
Subsequent measurement – IFRS
Subsequent to the initial recognition, IFRS requires lessees to record depreciation on the right-of-use asset, recognize interest expense on lease liability, and reduce the balance of the lease liability by the amount of least payment in excess of interest. Under IFRS, the principal part of lease outflow is classified as financing and the interest portion is classified either as operating or financing.
Subsequent measurement – US GAAP
US GAAP, on the other hand, categorizes assets into a finance lease and operating lease subsequent to initial recognition. A lease is treated as a finance lease if the benefits and risks of owning the leased asset have been transferred to the lessee. Accounting treatment for a finance lease is similar to IFRS treatment for the right-of-use asset, but for operating leases, a lessee recognizes a single lease expense which is based on the straight-line allocation of the cost of the lease over its term. On the cash flow statement, outflow related to operating leases is recognized as an operating activity.
Exceptions from capitalization requirement
Exceptions from capitalization exist for short-term leases and leases of assets with low value. Rent paid is expenses directly and shown as operating cash outflow.