What is lease accounting?
A lease gives a business the right to use an asset for a period in exchange for payments. Before 2019, many leases were "off balance sheet". IFRS 16 Leases and US GAAP ASC 842 changed that, bringing most leases onto the balance sheet.
Lessee accounting under IFRS 16
- Right-of-use (ROU) asset: recognised at the start of the lease, usually equal to the lease liability plus initial direct costs.
- Lease liability: the present value of future lease payments, discounted at the interest rate implicit in the lease or the incremental borrowing rate.
- Each period: depreciate the ROU asset and record interest on the liability; payments reduce the liability.
Exemptions
Leases of 12 months or less and leases of low-value assets (such as laptops or phones) can be expensed straight-line, like rent.
Example
A company leases an office for five years at $24,000 a year. At a 6% discount rate, the present value of payments is about $101,100. It records a $101,100 ROU asset and lease liability. Each year it depreciates the asset by about $20,220 and records interest that falls over time.
US GAAP difference
ASC 842 keeps a distinction between finance leases and operating leases for lessees. Operating leases still go on the balance sheet but show a single straight-line lease cost.
Why it matters
Lease accounting increases reported assets, liabilities and [EBITDA](/glossary/ebitda), which can affect loan covenants and ratios.