Accounting Term assignment

Since the Enron sandal in 2001, Security Exchange Commission (SEC has made closing loopholes it’s hope priority. The SEC realized that there was a loophole relating to leasing. In 2006, FASB began to work on a new lease accounting standard intended to close the loophole of off-balance operating leases. The FASB and IASB issued a Discussion Paper proposing that lessees capitalize all leases on the balance sheet was done in 2009. In 2010, the FASB and IASB issued an Exposure Draft and distribute it for public comments. The model set forth in the ED proposed that lessees move all leases onto the balance sheet as a right-of-use asset and liability.

By 2013, the FASB and IASB issued a Revised Exposure Draft and opened a four-month comment period. After, the boards solidified parts of the standard, including that all leases would be brought onto the balance sheet, expense recognition models, and liability measurement. In 2016, the FASB published ASC-842, the new lease accounting standard for companies reporting under US GAAP. The IASB issued IFRS 16 the new lease accounting standard for companies reporting under the International Financial Reporting Standards.

In 2018, the FASB issued an update to ASC 842 to both clarify and simplify the application of the new lease standard to land easements. The FASB also issued a proposal to ease companies’ transition to the new standard by offering a practical expedient that would allow companies to apply the transition provisions at the adoption date, instead of at the earliest comparative period. The proposal was approved in July of 2018.

The objective of the Research Project is to describe some of the key differences of presenting and reporting Leasing in the Financial Statements under U.S. GAAP and IFRS.

This paper starts by presenting the guidance applicable to Inventory under US GAAP and IFRS, this section contains the specific reference in each case as well as an illustrative case, who serves as an example of the application of the referred guidance. This section is followed by a little of history. A summary of History of Convergence by each standard as well a history of convergence between them. After having a theoretical picture of the Accounting Standards that rule Inventory, I compare both, beginning with its similarities and then explaining each of the differences encountered. Finally, I talked about the expectation of greater convergence between IFRS and US GAAP, exposing its possible impact and the elements that impede the complete convergence between them. At the end, the conclusions of this paper.

The primary US GAAP and SEC guidance applicable to leasing accounting is the ASC 842 Leasing.

A lessee shall either present in the statement of financial position or disclose in the notes all of the following:

a. Finance lease right-of-use assets and operating lease right-of-use assets separately from each other and from other assets

b. Finance lease liabilities and operating lease liabilities separately from each other and from other liabilities.

Right-of-use assets and lease liabilities shall be subject to the same considerations as other nonfinancial assets and financial liabilities in classifying them as current and noncurrent in classified statements of financial position. In the statement of comprehensive income, a lessee shall present both of the following:

a. For finance leases, the interest expense on the lease liability and amortization of the right-of-use asset are not required to be presented as separate line items and shall be presented in a manner consistent with how the entity presents other interest expense and depreciation or amortization of similar assets, respectively.

b. For operating leases, lease expense shall be included in the lessee’s income from continuing operations.

The primary IFRS guidance applicable to leasing accounting is IFRS 16.

GAAP is an acronym for Generally Accepted Accounting Principles which is followed by countries like the United States of America. In addition, GAAP is a set of rules and standards for financial reporting. The Great Depression in 1929 caused years of hardship for millions of American, it was primarily attributed to faulty and manipulative reporting practices among business. Historically, people did not have any guidelines for reporting which results in negative outcomes, hence the necessity of creating a uniform set of principles made the GAAP born and evolve to present times.

The United States has claimed to be working towards developing a single set of high quality, useful financial statements for all of its investors. Throughout its history, its standard setters (first the Accounting Principles Board and the Committee on Accounting Procedure, then the FASB) have attempted to protect the investor and other users of the financial statement, rather than the corporate preparers. As such, it has developed and expanded its own set of standards in line with its people's needs instead of converging with international standards that attempt to meet the needs of all parties globally. The United States has made strides towards the comparability of its firms' financial statements and has historically been one of the leaders in not only setting accounting standards, but also working towards harmonization of global accounting standards.

In 2005, the US Securities and Exchange Commission (SEC) expressed concerns about the lack of transparency of information about lease obligations, reiterating concerns already expressed by investors and others. Responding to those concerns, the IASB and the US national standard-setter, the Financial Accounting Standards Board (FASB), initiated a project to improve the accounting for leases. The IASB and the FASB agreed that a customer (lessee) leasing assets obtains an asset and typically also a liability at the start of a lease. However, applying previous lease accounting requirements, most leasing transactions were not reported on a company’s balance sheet; so these assets and liabilities were not recognized. Listed companies using IFRS or US GAAP disclosed almost US$3 trillion of off-balance sheet lease commitments in 2014.

The International Accounting Standards Board (IASB) issued IFRS 16 Leases in January 2016. IFRS 16 sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract, the customer (‘lessee’) and the supplier (‘lessor’). IFRS 16 is effective from 1 January 2019. A company can choose to apply IFRS 16 before that date but only if it also applies IFRS 15 Revenue from Contracts with Customers. IFRS 16 completes the IASB’s project to improve the financial reporting of leases. IFRS 16 replaces the previous leases Standard, IAS 17 Leases, and related Interpretations.

The similarity between the two sets of standards for lessees is also the biggest improvement in the lease accounting model. Both standards require the recognition of a right-of-use asset and a lease liability on the balance sheet for all leases.

There are significant differences between U.S. GAAP and IFRS with respect to accounting for Leasing, which include:

In US GAAP, here is no recognition exemption for leases based on the value of the underlying asset. In IFRS, Lessees may elect, on a lease-by-lease basis, not to recognize leases when the value of the underlying asset is low (e.g., US$5,000 or less when new).

In US GAAP all leases of intangible assets are excluded from the scope of ASC 842. In IFRS, lessees may apply IFRS 16 to leases of intangible assets other than rights held by a lessee under licensing agreements within the scope of IAS 38, Intangible Assets, for items such as motion picture films, video recordings, plays, manuscripts, patents and copyrights. Lessors are required to apply IFRS 16 to leases of intangible assets, except for licenses of intellectual property that are in the scope of IFRS 15.

Lease liability reassessment of variable lease payments

In US GAAP, Changes in variable lease payments based on an index or rate result in a remeasurement of the lease liability when the lease liability is remeasured for another reason (e.g., a change in the lease term). In IFRS, Changes in variable lease payments based on an index or rate result in a remeasurement of the lease liability whenever there is a change in the cash flows (i.e., when the adjustment to the lease payments takes effect).

Determination of the discount rate

In US GAAP, lessees and lessors determine the discount rate at the lease commencement date. In IFRS, Lessees determine the discount rate at lease commencement, but lessors determine the rate implicit in the lease at the lease inception date.

Lessee & Lessor lease classification

In US GAAP, recognized leases are classified as either finance or operating. Lessees classify leases at the lease commencement date. Leases are classified as operating, direct financing or sales-type leases at the lease commencement date. In IFRS, all recognized leases are accounted for similarly to finance leases under ASC 842. Leases are classified as operating or finance leases at the inception date of the lease.

Lessee Accounting: Short-term leases — existence of a purchase option & change in lease term

In US GAAP, A lease may not qualify as a short-term lease if it includes a purchase option that is reasonably certain to be exercised. A lease no longer qualifies as a short-term lease when there is a change in a lessee’s assessment of either of the following: The lease term so that, after the change, the remaining lease term extends more than 12 months from the end of the previously determined lease term and whether the lessee is reasonably certain to exercise an option to purchase the underlying asset. In IFRS, A lease may not qualify as a short-term lease if it includes a purchase option, regardless of whether the lessee is reasonably certain to exercise the option. A change in the terms of a short-term lease creates a new lease. If that new lease has a lease term greater than 12 months, it cannot qualify as a short-term lease.

Lessor Accounting: Recognition of selling profit for direct financing leases

In US GAAP, selling profit on direct financing leases is deferred at lease commencement and amortized into income over the lease term. In IFRS, IFRS does not distinguish between sales-type and direct financing leases. Selling profit on finance leases is recognized at lease commencement.

Lessor Accounting: Recognition of selling profit for direct financing leases

In US GAAP, selling profit on direct financing leases is deferred at lease commencement and amortized into income over the lease term. In IFRS, IFRS does not distinguish between sales-type and direct financing leases. Selling profit on finance leases is recognized at lease commencement.

Lessor Accounting: Collectability

In US GAAP, Collectability of the lease payments is assessed for purposes of initial recognition and measurement of sales-type leases. It is also evaluated to determine the income recognition pattern of operating leases. In IFRS, IFRS 16 does not include explicit guidance for considering collectability of lease payments.

Gain or loss recognition in sale and leaseback transactions

In US GAAP, the seller-lessee recognizes any gain or loss, adjusted for off-market terms, immediately. In IFRS, the seller-lessee recognizes only the amount of any gain or loss, adjusted for off-market terms, that relates to the rights transferred to the buyer-lessor.

Leveraged leases

In US GAAP, leveraged lease accounting is eliminated for leases that commence on or after the effective date of ASC 842. However, leveraged leases that commenced prior to the effective date are grandfathered. If an existing leveraged lease is modified on or after the effective date, the lease would no longer be accounted for as a leveraged lease but would instead be accounted for under ASC 842. In IFRS, the seller-lessee recognizes only the amount of any gain or loss, adjusted for off-market terms, that relates to the rights transferred to the buyer-lessor.

It is apparent from the comparison of GAAP and IFRS, that GAAP aims to provide definitive answers to potential questions while IFRS intends to create a principle based framework. Despite GAAP’s attempt to provide specific guidance on issues, GAAP will never be fool proof. The success of GAAP is directly dependent on its application and its ability to adjust to an evolving global economy. We believe that as globalization progresses we will see more and more instances of GAAP failing to evolve, failing to adjust to new accounting scenarios and failing to timely address accounting problems.