A company can promise to pay rent for ten years, fund a pension for forty, and grant stock options vesting over five. Historically much of that economic obligation lived outside the balance sheet. Current standards drag those promises back on.
Under both IFRS 16 and ASC 842, a lessee recognizes a right-of-use (ROU) asset and a lease liability at lease commencement. Both are measured at the present value of future lease payments, discounted at the rate implicit in the lease or the lessee's incremental borrowing rate.
The split happens on the income statement.
*IFRS allows interest in either operating or financing.
HIGH-FREQUENCY: IFRS uses a single finance model for all lessee leases. US GAAP retains a dual classification. The balance sheet looks similar; the income statement and cash flow classifications diverge.
Classification under US GAAP. A lease is finance if it meets any one of five criteria: transfer of ownership, purchase option reasonably certain, term covers a major part of economic life, present value equals substantially all fair value, or the asset is specialized with...
Common mistakes
- Confusing IFRS and US GAAP lessee classification. IFRS uses a single finance model. US GAAP keeps finance and operating split. Trap: "IFRS reports operating lease expense straight-line", false, IFRS has no operating lease for lessees.
- Forgetting that operating leases under US GAAP still capitalize an ROU asset. Pre-ASC 842 operating leases sat off-balance-sheet. Post-2019 they do not. Trap: "operating leases stay off the balance sheet under US GAAP."
- Using ABO instead of PBO for funded status. Funded status uses PBO (projected, including salary growth), not ABO (accumulated, current salaries only). Trap: subtracting ABO from plan assets.
Bottom line
- Lessees recognize a right-of-use (ROU) asset and lease liability for nearly all leases under both IFRS and US GAAP. The split shows in the income statement.
- Finance/IFRS leases: interest plus amortization (front-loaded total expense). US GAAP operating lease: a single straight-line expense.
- Lessors classify leases as finance (sales-type or direct financing) versus operating, based on transfer of risks and rewards.
- DB plans put funded status (plan assets minus PBO) on the balance sheet. DC plans only expense the contribution.
Exam shortcut
For lessee leases, memorize "IFRS = one model, US GAAP = two." For DB funded status, use assets minus PBO, never ABO. For stock-based comp, equity-settled awards fix fair value at grant while cash-settled awards remeasure every period. If the question mentions SARs settled in cash, expect period-by-period revaluation.
The full lesson (about 2,157 words, 14 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- long-term liabilities and equity
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