Both leases and rentals allow one party, the lessee / rentee, to use an asset owned or controlled by another party, the lessor / rentor. The difference, lease agreements cover a long period of time, while rental agreements do not.
For example, a lessor may lease a building from its owner and sub-lease individual units to sub-lessees.
Technically, from a semantic perspective, a renter owns the asset being rented while a rentor does not.
Fortunately, no similar semantic distinction is made for lessors.
Technically, from a IFRS | US GAAP perspective, there is no difference between a rent and a lease.
IFRS 16 defines a lease: a contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.
Similarly, ASC 842 defines a lease: a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.
Thus, while not identical in how they define the object of a lease, the standards do agree that a right to use an asset for a period of time, any period of time (whether specified or not), is a lease.
Nevertheless, if the term is one year or less, lease accounting is not mandatory.
As outlined in IFRS 15 5.a | ASC 842-20-25-2, lease accounting is mandatory only if the term exceed one year.
IFRS 16.5.b includes a second exception for low valued assets.
A discussion of this issue, including how to quantify "low value," can be found in the illustrations that follow.
ASC 842 does not provide a similar exception.
This implies, while any agreement defining a term may be accounted for as a lease, short term leases may be accounted for as rentals.
Note: it is also possible for an agreement to specify an indefinite term. However, as this is common mostly with real-estate, illustrations of how to account for this type of agreement are provided in the real-estate section below.
Note: the guidance does not specifically state that, in this situation, the agreement should be recognized as a rental, mostly because it is obvious.
1/1/X1, ABC "rented" an automobile for one year while XYZ "leased" an identical vehicle for 12 months.
As noted above, there is no difference between a rental and a lease from an IFRS | US GAAP perspective.
Nevertheless, both require lease accounting only if the term exceeds one year.
As the neither standard specifies how a lease not accounted for as a lease should be recognized, calling it rent would not contradict any guidance.
As noted above, IFRS 15 5.a | ASC 842-20-25-2 provide an exception to lease accounting. However, entities are not required to apply this exception and may recognize any lease using lease accounting.
Both agreed to pay the vehicle’s owner 342 at the end of each month.
While arrears payments are relatively uncommon, they provide a better illustration of the accounting.
The accounting for advance payments is shown in the explicit rate example below.
|
1/31 to 12/31/X1 | 31.1 to 31.12.X1 |
|
|
|
342 |
|
||
|
Cash |
|
342 |
This expense would be reported to reflect how the vehicle was used. For example, it was used by management, it would be reported in administrative expenses.
Note: if the automobile was also available for the employee’s personal use, a portion of the expense would be reported in employee benefits as a perquisite.
|
1/1/X1 | 1.1.X1 |
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|
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As outlined in IFRS 16.23 | ASC 842-20-25-1, the asset recognized in a lease agreement is a "right-of-use asset."
While the leased asset itself is generally tangible, a right conveyed by an agreement is clearly intangible.
In a subtle difference, IFRS 16 defines a lease (emphasis added): A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.
In contrast, ASC 842-20 defines a lease (emphasis added): A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.
This implies, while an "underlying asset" could theoretically be intangible, an "identified asset" will always be tangible.
Both IFRS 38 Definitions and ASC 350-30-20 define intangible asset comparably as assets (not including financial assets) that lack physical substance.
Both IAS 38.12.b and ASC 805-20-20 also elaborate that intangible asset arise from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
An ROU clearly fulfills this guidance and so is an intangible asset.
Nevertheless, even though ROUs associated short-term leases could, theoretically, be recognized and reported in PP&E, capitalizing them at all would not be good accounting.
In practice, short-term leases are never capitalized.
Consequently, speculating on how they would be recognized and reported if they were capitalised is similar to speculating how many could dance on the head of a pin, if they could dance.
As discussed in the implicit and explicit rate illustrations below, decision usefulness for users of financial information is a key consideration.
As most users do not consider items leased for a short-term to be assets, capitalizing these ROUs would be misleading.
Nevertheless, as this policy is not explicitly disallowed, it could (theoretically) show up in practice.
The 2023 revision to the IASB XBRL introduced PropertyPlantAndEquipmentIncludingRightofuseAssets and RightofuseAssets.
Similarly, the FASB XBRL presents FinanceLeaseRightOfUseAsset separatly from both PropertyPlantAndEquipmentNet and IntangibleAssetsNetExcludingGoodwill.
This suggests both the IASB and FASB are of the opinion that ROU's should be reported outside of PP&E.
However, XBRL is not a standard. So, since neither IFRS 16 nor ASC 842 explicitly disallow the practice, ROUs may be recognized and reported as PP&E.
IFRS 16.47 merely states: A lessee shall either present in the statement of financial position, or disclose in the notes:
- right-of-use assets separately from other assets. If a lessee does not present right-of-use assets separately in the statement of financial position, the lessee shall:
- include right-of-use assets within the same line item as that within which the corresponding underlying assets would be presented if they were owned; and
- disclose which line items in the statement of financial position include those right-of-use assets.
- lease liabilities separately from other liabilities. If the lessee does not present lease liabilities separately in the statement of financial position, the lessee shall disclose which line items in the statement of financial position include those liabilities.
Also, IFRS 16.53.j states: the carrying amount of right-of-use assets at the end of the reporting period by class of underlying asset.
This is often interpreted to mean that an ROU should be recognized and reported together with similar items of PP&E.
This interpretation is further reinforced by IFRS 16.31: "A lessee shall apply the depreciation requirements in IAS 16 Property, Plant and Equipment in depreciating the right-of-use asset, subject to the requirements in paragraph 32" suggesting that an ROU is a type of PP&E and should be treated as such.
ASC 842-20-45-1 merely states: A lessee shall either present in the statement of financial position or disclose in the notes all of the following:
- Finance lease right-of-use assets and operating lease right-of-use assets separately from each other and from other assets
- 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.
ASC 842-20-45-2 states: If a lessee does not present finance lease and operating lease right-of-use assets and lease liabilities separately in the statement of financial position, the lessee shall disclose which line items in the statement of financial position include those right-of-use assets and lease liabilities.
ASC 842-20-45-3 states: In the statement of financial position, a lessee is prohibited from presenting both of the following:
- Finance lease right-of-use assets in the same line item as operating lease right-of-use assets
- Finance lease liabilities in the same line item as operating lease liabilities.
The guidance merely prohibits mixing financial with operating leases. It does not state they cannot both be recognized and reported in PP&E.
The key reason IFRS 16 | ASC 842 replaced IAS 17 | ASC 840 was that the latter gave companies considerable latitude in classifying leases as operating rather than finance | capital.
This latitude was used, some say abused, to keep vast amounts of assets and liabilities off the balance sheet and was the personal bugbear of Sir David Tweedy, the first IASB chairman, who vowed to stamp out this abuse and who retired, presumably a happy man, once the mission had been accomplished.
Ironically, while the IASB took the lead on this convergence issue, IFRS is softer than US GAAP even though US GAAP (nominally) held on to operating leases.
In addition to an exception for short term leases, IFRS 16.5.b also exempts low valued assets.
As this exemption does not consider the materially of the exempted items with respect to the entity (IFRS 16.B4), companies can recognize large numbers of low value assets without having to recognize either them, or the associated liabilities, on the balance sheet.
As ASC 842-20-25 does not include a similar "small asset" exception, this is an IFRS only issue.
Although ASC 842-20-25-6 allows some leases to be recognized as operating, the only different between this paragraph and ASC 842-20-25-5 is it allows lessees to report a straight-line expense instead of requiring the effective interest method (which causes expenses to be front loaded as illustrated below).
It does not exempt lessees from reporting an asset and liability (the way superseded ASC 840 did).
As outlined in IFRS 16.24 | ASC 842-20-30-5, the value of the ROU is derived from the value of the lease liability.
Under previous GAAP, the procedure was reversed. The value of the liability was derived from the value of the asset. Specifically, IAS 17.20 used a fair value or present value whichever was lower approach, while the approach in ASC 840-30-30-3 was present value or fair value whichever was lower.
From a practical perspective, since the asset and liability must equal, it makes little difference which is measured first.
Nevertheless, occasionally, such as if a lease term is not defined or indefinite, keeping in mind that the liability comes first makes applying the guidance easier. An illustration of this is provided in the real estate section below.
XYZ calculated the ROU's value using this table:
Perhaps the simplest way to calculate present value is using the table below.
It can also be determined using Excel's present value function =PV(rate, nper, pmt, [fv], [type]).
Note, the rate must correspond to the periodicity of the payment. In this example, the annual rate needs to be converted to a monthly rate: 0.604¯% = (1 + 7.5%)1/12 - 1 (simply dividing by 12 will not yield an accurate result).
Present value may also be calculated using this formula (in Excel syntax):
=C1*((1-(1+((1+D1)^(1/B1)-1))^(-A1*B1+1))/((1+D1)^(1/B1)-1))+C1
Where: A1 = number of annual periods, B1 = number of interim periods, C1 = the payment, D1 = the annual rate.
For a payment in arrears the formula is:
=C1*((1-(1+((1+D1)^(1/B1)-1))^(-A1*B1))/((1+D1)^(1/B1)-1))
To prevent rounding errors, it is good to round the result.
=ROUND(C1*((1-(1+((1+D1)^(1/B1)-1))^(-A1*B1+1))/((1+D1)^(1/B1)-1))+C1,2)
=ROUND(C1*((1-(1+((1+D1)^(1/B1)-1))^(-A1*B1))/((1+D1)^(1/B1)-1)),2)
These formulas and others like them can be downloaded on the formulas page.
In contrast to IAS 17 / ASC 840, where the value of the lease liability was derived from the value of the leased asset, under IFRS 16.24.a | ASC 842-20-30-5, the value of ROU is derived from the value of the liability.
As outlined in IFRS 16.26 | ASC 842-20-30-1, the liability is measured at the present value of lease payments.
In this illustration, that value was determined using an (annual) discount rate of 7.5%.
Additional discussion of how to determine an appropriate discount rate is provided in the illustrations that follow.
|
P |
Payment |
Discount rate |
Present value |
|
A |
B |
C = (1 + 7.5%)1/12 - 1 |
D = B ÷ (1 + C)A |
|
1 |
342 |
0.604% |
340 |
|
2 |
342 |
0.604% |
338 |
|
- |
- |
- |
- |
|
11 |
342 |
0.604% |
320 |
|
12 |
342 |
0.604% |
318 |
|
|
|
|
3,947 |
|
|
|
|
|
|
1/31/X1 | 31.1.X1 |
|
|
|
|
|
|||
|
|
|
329 |
|
|
Lease liability |
|||
|
Interest expense |
24 |
|
|
|
|
Cash |
|
342 |
Whether a depreciation or amortization expense was recognized depends on if the ROU was recognized in PP&E (depreciation) or separately from PP&E (amortization).
This expense would be reported to reflect how the vehicle was used. For example, it was used by management, it would be reported in administrative expenses.
Note: if the automobile was also available for the employee’s personal use, a portion of the expense would be reported in employee benefits as a perquisite.
XYZ elected to depreciate / amortize the asset straight-line to a zero residual | salvage value: 3,947 ÷ 12 = 328.92.
Whether an accumulation account us used depends on if the ROU was recognized under IFRS or US GAAP.
Specifically, IAS 38.74 states: After initial recognition, an intangible asset shall be carried at its cost less any accumulated amortisation ...
In contrast, common US GAAP practice is to amortize intangible assets directly, without an accumulation account.
Thus, since an ROU is, technically, an intangible asset, an accumulation account is optional.
This table illustrates the amortization of the liability using the effect interest method.
However, if this transaction was recognized under US GAAP, it would be an operating lease and a straight-line expense would be recognized. An illustration of the GAAP for operating leases is presented below.
|
P |
Liability |
Discount rate |
Interest expense |
Payment |
Liability amortization |
|
A |
B (B+1) = B - F |
C |
D = B x C |
E |
F = E - D |
|
1 |
3,947 |
0.604% |
24 |
342 |
318 |
|
2 |
3,629 |
0.604% |
22 |
342 |
320 |
|
- |
- |
- |
- |
- |
- |
|
11 |
678 |
0.604% |
4 |
342 |
338 |
|
12 |
340 |
0.604% |
2 |
342 |
340 |
|
|
|
|
|
|
3,947 |
|
|
|
|
|
|
|
|
12/31/X1 | 31.12.X1 |
|
|
|
|
Depreciation or Amortization |
329 |
|
|
|
|
Accumulated depreciation or amortization (ROU) |
|
329 |
|
Lease liability |
340 |
||
|
Interest expense |
2 |
|
|
|
|
Cash |
|
342 |
If an accumulated depreciation or amortization account had been used, the asset would need to be derecognized.
|
12/31/X1 | 31.12.X1 |
|
|
|
|
Accumulated depreciation or amortization (ROU) |
3,947 |
|
|
|
PP&E: Vehicles: Automobiles (ROU) |
|
3,947 |
If it was depreciation / amortized directly, this step would not be necessary.
1/1/X1, XYZ leased a standard production machine. It agreed to make 5 annual payments of 2,927 (in arrears). At the end of the lease term, title to the machine passed to XYZ.
While arrears payments are relatively uncommon, they provide a better illustration of the accounting.
The accounting for advance payments is shown in the explicit rate example below.
On average, XYZ uses comparable machines it purchases outright for 6 years, after which it sells them for 10% of their acquisition cost. It actually sold the machine for 1,250 on 3/31/X7.
1/1/X1 | 1.1.X1 |
|
|
|
|
|||
|
Lease liability |
|
|
As outlined in IFRS 16.23 | ASC 842-20-25-1, the asset recognized in a lease agreement is a "right-of-use asset."
While the leased asset itself is generally tangible, a right conveyed by an agreement is clearly intangible.
In a subtle difference, IFRS 16 defines a lease (emphasis added): A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration.
In contrast, ASC 842-20 defines a lease (emphasis added): A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.
This implies, while an "underlying asset" could theoretically be intangible, an "identified asset" will always be tangible.
Both IFRS 38 Definitions and ASC 350-30-20 define intangible asset comparably as assets (not including financial assets) that lack physical substance.
Both IAS 38.12.b and ASC 805-20-20 also elaborate that intangible asset arise from contractual or other legal rights, regardless of whether those rights are transferable or separable from the entity or from other rights and obligations.
An ROU clearly fulfills this guidance and so is an intangible asset.
Nevertheless, if the asset is retained, recognizing and reporting it as intangible is frowned upon, as is the mezzanine level.
From an IFRS perspective, the most common justification for not recognizing and reporting ROUs as intangible assets is IFRS 16.31, which requires an ROU to be depreciated as outlined in IAS 16 (rather than amortised as outlined in IAS 38) implying an ROU belongs in PP&E.
From a US GAAP perspective, ASC 842-20-35-7 refers to amortization (not depreciation) and establishes the straight-line method as a default (like ASC 350-30-35-6 does for intangible assets). This suggests an ROU belongs in intangible assets.
However, if the asset is retained, this would require derecognizing an intangible asset and rerecognizing PP&E at the end of the lease term.
Not that a mere accounting inconvenience is sufficient grounds for missaying the guidance.
More importantly, such policy would contradict the FASB's intent.
As stated in ASU 2016-02.BC4: Given the objective of general purpose financial reporting, the Board also considered the objective of the leases project, which is to increase the decision usefulness and comparability among organizations by recognizing lease assets and lease liabilities on the statement of financial position and disclosing key leasing information. For example, users of financial statements are interested in obtaining information about a lessee’s leasing activities, in general, to assess the cash flows, returns, and capital structure of the lessee and to assess the lessee’s ability to meet financial commitments. Most users already make adjustments that are often based on incomplete information to a lessee’s reported statement of financial position to capitalize operating leases when operating leases are significant to the lessee.
Reading between the lines one realizes that users of financial statements prefer to get their information in the most digestible form possible.
So, if users can compare two companies, one that leases its assets and one that buys them on credit, by simply laying their two balance sheets side by side, they will be more satiated than if they have to chew through gristle hidden in the footnotes.
Thus, from both an IFRS and US GAAP perspective, since this accounting policy increases decision usefulness without violating any explicit guidance, there is no reason a leased asset should not be recognized and reported in PP&E even though it is, technically, an ROU.
In the 2023 revision to its XBRL, the IASB introduced PropertyPlantAndEquipmentIncludingRightofuseAssets and RightofuseAssets.
This implies the IASB is of the opinion that ROU's should be reported as stand-alone items separate from both PP&E and Intangible assets (in the mezzanine).
Similarly, the FASB XBRL also presents FinanceLeaseRightOfUseAsset separatly from both PropertyPlantAndEquipmentNet and IntangibleAssetsNetExcludingGoodwill.
Be that as it may, using a mezzanine level screams management indecision, which makes some users of financial information antsy.
So, since neither IFRS 16 nor ASC 842 explicitly state ROUs may not be recognized and reported as PP&E, recognizing and reporting them in this way would not contradict the guidance they provide.
IFRS 16.47 merely states: A lessee shall either present in the statement of financial position, or disclose in the notes:
- right-of-use assets separately from other assets. If a lessee does not present right-of-use assets separately in the statement of financial position, the lessee shall:
- include right-of-use assets within the same line item as that within which the corresponding underlying assets would be presented if they were owned; and
- disclose which line items in the statement of financial position include those right-of-use assets.
- lease liabilities separately from other liabilities. If the lessee does not present lease liabilities separately in the statement of financial position, the lessee shall disclose which line items in the statement of financial position include those liabilities.
Also, IFRS 16.53.j states: the carrying amount of right-of-use assets at the end of the reporting period by class of underlying asset.
This is often interpreted to mean that an ROU should be recognized and reported together with similar items of PP&E.
This interpretation is further reinforced by IFRS 16.31: "A lessee shall apply the depreciation requirements in IAS 16 Property, Plant and Equipment in depreciating the right-of-use asset, subject to the requirements in paragraph 32" suggesting that an ROU is a type of PP&E and should be treated as such.
ASC 842-20-45-1 merely states: A lessee shall either present in the statement of financial position or disclose in the notes all of the following:
- Finance lease right-of-use assets and operating lease right-of-use assets separately from each other and from other assets
- 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.
ASC 842-20-45-2 states: If a lessee does not present finance lease and operating lease right-of-use assets and lease liabilities separately in the statement of financial position, the lessee shall disclose which line items in the statement of financial position include those right-of-use assets and lease liabilities.
ASC 842-20-45-3 states: In the statement of financial position, a lessee is prohibited from presenting both of the following:
- Finance lease right-of-use assets in the same line item as operating lease right-of-use assets
- Finance lease liabilities in the same line item as operating lease liabilities.
The guidance merely prohibits mixing financial with operating leases. It does not state they cannot both be recognized and reported in PP&E.
As outlined in IFRS 16.24 | ASC 842-20-30-5, the value of the ROU is derived from the value of the lease liability.
Under previous GAAP, the procedure was reversed. The value of the liability was derived from the value of the asset. Specifically, IAS 17.20 used a fair value or present value whichever was lower approach, while the approach in ASC 840-30-30-3 was present value or fair value whichever was lower.
From a practical perspective, since the asset and liability must equal, it makes little difference which is measured first.
Nevertheless, occasionally, such as if a lease term is not defined or indefinite, keeping in mind that the liability comes first makes applying the guidance easier. An illustration of this is provided in the real estate section below.
IFRS 16.24 | ASC 842-20-30-5 requires the value of the ROU to be derived from the value of the lease liability.
In addition to the liability itself (sub-paragraph a), the cost of the ROU also comprises:
(b) lease payments made at or before the commencement date (less incentives received) and
(c) initial direct costs incurred by the lessee.
Note: IFRS 24.d also specifies that disposal costs should be included in the ROU, while ASC 842-20-30-5 does not.
This should not, however, be interpreted to imply that disposal costs are not recognized under US GAAP.
Instead, it reflects that while IFRS approaches disposal from the perspective of the asset, US GAAP approaches it the perspective of the liability.
Consequently, if an entity expects to incur disposal costs, it would recognize them as outlined in ASC 410-20.
Also note: while similar, IFRS | US GAAP guidance on disposal costs | retirement obligations does include some important differences which are and is discussed on Non-current assets page.
However, it also requires this liability to be calculated using the rate implicit in the lease (if readily determinable).
As the rate implicit in the lease is derived from the value of the leased asset, the guidance seems to be circular.
IFRS 16 defines the interest rate implicit in the lease as (emphasis added): the rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.
ASC 842-20 defines the rate implicit in the lease as (emphasis added): the rate of interest that, at a given date, causes the aggregate present value of (a) the lease payments and (b) the amount that a lessor expects to derive from the underlying asset following the end of the lease term to equal the sum of (1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized by the lessor and (2) any deferred initial direct costs of the lessor. However, if the rate determined in accordance with the preceding sentence is less than zero, a rate implicit in the lease of zero shall be used.
Note: while ASC 842-20 indicates that the implicit rate could be zero, it does not provide any examples of situations where this would be the case.
It is not because the leased asset and the ROU (the right to use that asset) are two separate items of which only one, the ROU, is recognized on the balance sheet.
Be that as it may, applying the guidance in practice is actually straight forward.
If the asset can be priced with little effort, the liability equals that market price and an implicit rate is calculated.
Both IFRS 16.26 and ASC 842-20-30-3, require the liability to be measured by discounting the lease payments using the rate implicit in the lease if this rate is readily determinable.
IFRS 16 defines the interest rate implicit in the lease as: the rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.
ASC 842-20 defines the rate implicit in the lease as: the rate of interest that, at a given date, causes the aggregate present value of (a) the lease payments and (b) the amount that a lessor expects to derive from the underlying asset following the end of the lease term to equal the sum of (1) the fair value of the underlying asset minus any related investment tax credit retained and expected to be realized by the lessor and (2) any deferred initial direct costs of the lessor. However, if the rate determined in accordance with the preceding sentence is less than zero, a rate implicit in the lease of zero shall be used.
Note: while ASC 842-20 indicates that the implicit rate could be zero, it does not provide any examples of situations where this would be the case.
However, neither specify how "readily determinable" should be interpreted.
Which, for some sites, represents a practically insurmountable hurdle, but only if forget to apply the latest update.
Under ASC 840, to use the rate implicit in the lease, the lessee really did need to know the lessor's profit margin. Since lessors rarely shared this information, this really was usually a Catch 22.
Previously, ASC 840-10-25-31 stated: A lessee shall compute the present value of the minimum lease payments using the lessee's incremental borrowing rate unless both of the following conditions are met, in which circumstance the lessee shall use the implicit rate:
a. It is practicable for the lessee to learn the implicit rate computed by the lessor.
b. The implicit rate computed by the lessor is less than the lessee's incremental borrowing rate.
However, under ASC 842, this is no longer necessary.
Currently, ASC 842-20-30-3 (edited) states: A lessee should use the rate implicit in the lease whenever that rate is readily determinable. If the rate implicit in the lease is not readily determinable, a lessee uses its incremental borrowing rate...
Instead, all the lessee needs to know is the regular sales price of the leased asset on the market. It does not need to know that price before a manufacturer's profit or dealer's markup.
Fortunately, readily determinable fair value is defined in ASC 820.
Unfortunates, this definition only applies to equity securities.
Nevertheless, by analogizing from this guidance, "readily determinable" can be interpreted to mean prices for comparable items which can be easily verified using objective, market data.
In other words, fair value is "readily determinable" if it can be found in price lists, blue books or using similar means (a.k.a. on the internet in less than an hour or so).
If, on the other hand, it requires something more involved, such as soliciting third party offers or calculating multi-period excess earnings, the cost, time and effort involved makes it not "readily determinable."
For its part, while IFRS 13 does not define readily determinable fair value. IFRS 13.B34 does discuss readily available closing prices in exchange markets.
Again, by analogizing from this guidance, it would be reasonable to interpret "readily determinable" the same way as above.
Assuming a plain vanilla transaction excluding, for example, a guaranteed residual amount.
If the asset cannot be priced with little effort, the liability equals lease payments discounted using an explicit rate.
IFRS 16.26 | ASC 842-20-30-3 specifies if an implicit rate is not (readily) available, an explicit rate is used instead.
This explicit rate is the lessee's incremental borrowing rate.
The following illustration discusses how to determine this rate.
Since the machine was easy to price, a liability of 12,000 was recognized and a rate of 7% calculated.
As the machine in this illustration was standard and prices of standard machines could be easily confirmed using published price lists, the implicit discount rate was readily determinable. In other words, the ROU and lease liability were measured at the machine's regular sales price and an implicit rate was calculated.
The simplest way to calculate this rate is Excel's rate function: =RATE(nper, pmt, pv, [fv], [type], [guess]):
Where: nper the number of periods, pmt the payment (must be negative), pv (present value) the fair value of the asset, [fv] (future value) should be 0, [type] should be 0 for an advance payment and 1 for an arrears payment, [guess] can be anything or left blank.
In this example, 7.00¯%=RATE(5,-2927,12000,0,0).
It can also be calculated using a present value table and trial and error:
|
P |
Payment |
Discount rate |
Present value |
|
A |
B |
C |
D = B ÷ (1 + C)A |
|
1 |
2.927 |
7% |
2,735 |
|
2 |
2.927 |
7% |
2,556 |
|
3 |
2.927 |
7% |
2,389 |
|
4 |
2.927 |
7% |
2,233 |
|
5 |
2.927 |
7% |
2,087 |
|
|
|
|
12,000 |
|
|
|
|
|
|
12/31/X1 | 31.12.X1 |
|
|
|
|
Interest expense (leasing) |
840 |
||
|
Lease liability |
|
||
|
|
Cash |
|
2,927 |
|
Depreciation expense (ROU) |
|
||
|
|
Accumulated depreciation (ROU) |
|
1,800 |
IFRS 16.31 requires lessees to depreciate leased assets as outlined in IAS 16.
This implies, if an entity purchases similar assets, it will depreciate the ROU using the same period, method and residual value as those assets.
If the entity does not purchase similar assets, it will depreciated the ROU using the same period, method and residual value it would have used if it had purchased the asset.
In contrast, ASC 842-20-35-7 states: A lessee shall amortize the right-of-use asset on a straight-line basis, unless another systematic basis is more representative of the pattern in which the lessee expects to consume the right-of-use asset's future economic benefits...
In this example, since XYZ retained the machine at the end of the lease term, it concluded that depreciating it the same way as similar assets it purchased would best represent how it consumed the ROU's economic benefits.
|
P |
Liability |
Discount rate |
Interest expense |
Payment |
Liability amortization |
|
A |
B (B+1) = B - F |
C |
D = B x C |
E |
F = E - D |
|
1 |
12,000 |
7.00% |
840 |
2,927 |
2,087 |
|
2 |
9,913 |
7.00% |
694 |
2,927 |
2,233 |
|
3 |
7,681 |
7.00% |
538 |
2,927 |
2,389 |
|
4 |
5,292 |
7.00% |
370 |
2,927 |
2,556 |
|
5 |
2,735 |
7.00% |
191 |
2,927 |
2,735 |
|
|
|
|
|
|
12,000 |
|
|
|
|
|
|
|
31/3/X7 | 3.31.X7 |
|
|
|
Accumulated depreciation (ROU) |
10,800 |
|
|
Cash |
1,250 |
|
|
|
Machine (ROU) |
|
12,000 |
|
Asset disposal gain |
|
50 |
Same facts except payments of 2,735 were paid at the beginning of the year.
1/1/X1 | 1.1.X1 |
|
|
|
Production machine |
12,000 |
|
|
|
Cash |
2,735 |
|
|
Lease liability |
|
9,265 |
|
12/31/X1 | 31.12.X1 |
|
|
|
|
Interest expense |
649 |
|
|
|
Lease liability |
|||
|
Depreciation expense |
1,800 |
|
|
|
|
Accrued lease payment |
|
|
|
|
Accumulated depreciation |
|
1,800 |
|
P |
Liability |
Discount rate |
Interest expense |
Payment |
Liability amortization |
|
A |
B (B+1) = B - F |
C |
D = B x C |
E |
F = E - D |
|
0 |
12,000 |
7.00% |
0 |
2,735 |
2,735 |
|
1 |
9,265 |
7.00% |
649 |
2,735 |
2,087 |
|
2 |
7,178 |
7.00% |
502 |
2,735 |
2,233 |
|
3 |
4,945 |
7.00% |
346 |
2,735 |
2,389 |
|
4 |
2,556 |
7.00% |
179 |
2,735 |
2,556 |
|
|
|
|
|
|
12,000 |
|
|
|
|
|
|
|
Principal and interest can also be recognized separately:
|
|
Accrued lease payment: Principal |
|
2,087 |
|
|
Accrued lease payment: Interest |
|
649 |
1/1/X2 | 1.1.X2 |
|
|
|
Accrued lease payment |
2,735 |
|
|
|
Cash |
|
2,735 |
Same facts except XYZ made quarterly accruals.
While the effective interest method can be applied with any periodicity, if the payments are annual, common practice is to make interim accruals on a straight-line basis.
|
3/31/X1 | 31.3.X1 |
|
|
|
|
Interest expense |
162 |
||
|
Lease liability |
522 |
|
|
|
Depreciation expense |
450 |
|
|
|
|
Accrued lease payment |
|
684 |
|
|
Accumulated depreciation |
|
450 |
1/1/X1, XYZ leased a made-to-order machine. It agreed to make 36 monthly payments of 342 and had an option to buy the machine for 1,000 at the end of the lease term.
XYZ used the machine for 6 years and scrapped it on 31/12/X6.
The remainder of this illustration is available in pro view.