ASC 842

Under ASC 842, the new lease accounting standard for US

companies following US GAAP, lessees are required to
recognize lease assets and lease liabilities on their balance
sheets for both operating and finance (previously capital)
leases. The lessee is required to perform a present value
calculation of future expected lease payments to establish
the lease liability and the related ROU asset. Accounting for
leases classified as operating leases is affected the most,
as leases classified as capital leases were already
recognized on the balance sheet under ASC 840. ASC 842 is
effective for nonpublic entities for fiscal years beginning
after December 15, 2021, and December 15, 2019, for
publicly-traded companies.

The accounting for the lessor is largely unchanged from ASC

840 to ASC 842. Lessors continue to recognize lease income
for their leases, and balance sheet recognition requirements
stay predominantly the same. The lease agreement’s
underlying asset will continue to be classified as the
lessor’s fixed asset.
Under ASC 842, there are three types of lessor leases:
 Direct Financing – lessors are required to establish a
lease receivable and interest income
 Sales Type – lessors are required to establish a lease
receivable and interest income. The difference between
direct financing and sales-type leases is revenue (With
a sales type, the lessee has control of the underlying
asset and the lessor recognizes sales revenue and
profit at lease commencement)
 Operating – lessors recognize income on a straight-line
basis
Lessees and lessors have the option to elect a package
of practical expedients to aid in the adoption of the new
standard, in which the lessor is not required to reassess
lease classification. Therefore, we expect many lessors to
elect this expedient and retain previously established lease
classifications when transitioning from ASC 840 to ASC 842.

ASC 842 lease accounting examples

Here are some articles to further explain finance and
operating lease accounting under ASC 842, including full
examples and journal entries:
 Operating Lease Accounting under ASC 842 Explained
with a Full Example
 Capital Lease Accounting and Finance Lease
Accounting under ASC 842 Explained with a Full
Example

Operating Lease
Accounting under ASC
842 Explained with a Full
Example
by Kiley Arnold, CPA, Sr. Product Marketing Manager | Mar 12, 2023
1. Operating lease treatment under ASC 842 vs. ASC 840:
What changed?
2. Operating lease vs. finance lease identification under
ASC 842
 Transference of title/ownership to the lessee
 Purchase option
 Lease term for major part of the remaining economic
life of the asset
 Present value represents “substantially all” of the
fair value of the asset
 Asset specialization
3. Is lease capitalization required for all operating leases
under 842?
4. Operating lease accounting example and journal entries
 Details on the example lease agreement
 Step 1: Determine the lease term under ASC 840
 Step 2: Determine the total lease payments under
GAAP
 Step 3: Prepare the straight-line amortization
schedule under ASC 840
 Step 4: On the ASC 842 effective date, determine the
total payments remaining
 Step 5: Calculate the operating lease liability
 Step 6: Calculate the right-of-use asset (with journal
entry)

Operating lease treatment

under ASC 842 vs. ASC 840:
What changed?
Under ASC 840, operating leases were considered off-
balance sheet transactions. The rent expense associated
with the arrangements was recognized in the income
statement, but nothing was recorded on the balance sheet.
This made it difficult to understand the total amount of
commitments a company had. It could also make
comparisons between companies difficult, depending on
their different approaches to leased vs. capital assets.
To increase transparency, the FASB issued ASC
842, Leases. One of the main provisions of this new
standard is that all leases must be recognized on a
company’s balance sheet. For operating leases, ASC 842
requires recognition of a right-of-use asset and a
corresponding lease liability upon lease commencement.
With the changes introduced under ASC 842, all leases are
now presented on both the balance sheet and income
statement whether they are operating or finance (capital)
leases. The updated financial statement presentation
requires issuers to show the operating ROU asset and
operating lease liability separately from the finance (capital)
ROU asset and lease liability both on the face of the
financials and in the notes disclosures.
However, the effect of operating leases on the income
statement is not changing. Companies will continue to
recognize a straight-line expense for the lease payments
made over the lease term as an operating expense on the
statement of profit and loss.

Operating lease vs. finance

lease identification under ASC
842
Operating vs. finance lease classification under ASC 842 is
relatively similar to the operating lease vs. capital lease
criteria under ASC 840, but certain “bright lines” for
classification have been removed, consistent with the more
“principles-based” approach of ASC 842. For a lease to be
classified as a finance lease, it must meet one of the five
criteria listed below. If the lease does not fall under any of
these criteria, it is classified as an operating lease:

1. Transference of title/ownership to
the lessee
Ownership of the underlying asset is transferred to
the lessee by the end of the lease term.

2. Purchase option
The lease arrangement grants the lessee an option to
purchase the asset, which is reasonably certain to be
exercised. It is important to note, the purchase option must
be reasonably certain to be exercised for this criteria to
met.
3. Lease term for major part of the
remaining economic life of the asset
The lease term spans a major part of the remaining
economic life of the underlying asset.
Note: The FASB provided additional clarification that “major
part” can be consistent with the 75% threshold used under
ASC 840. Companies are allowed to determine how they
will define the “major part” threshold. In practice, though, a
large portion of organizations tend to lean towards using the
75% threshold previously seen in ASC 840.
4. Present value represents
“substantially all” of the fair value of
the asset
The present value of the sum of the remaining lease
payments equals or exceeds substantially all of the
underlying asset’s fair value. If applicable, any residual
value guarantee by the lessee not already included in lease
payments is also included in the present value calculation.
Note: The FASB provided some additional clarification that
“substantially all” can be consistent with the 90% threshold
used under ASC 840. Here also, companies are allowed to
determine their own “substantially all” threshold, but in
practice the majority of entities are continuing to use 90%.

5. Asset specialization
The underlying asset is of such a specialized nature that it is
expected to have no alternative use to the lessor at the
end of the lease term.
Is lease capitalization
required for all operating
leases under 842?
An entity can establish an accounting policy to exclude
operating leases with a lease term of 12 months or less at
lease commencement (provided they also do not have a
purchase option that is reasonably certain of exercise)
from capitalization on the balance sheet. Further, while ASC
842 does not have an exclusion for low-value assets, some
companies have established a capitalization threshold.
Similar to a capitalization threshold for fixed assets, the
company has determined that leases below this value are
not material to the company and therefore, are not
recognized on the balance sheet.

Operating lease accounting

example and journal entries
The following is a full example of how to transition an
operating lease initially recorded under ASC 840 to ASC 842
accounting treatment.

Details on the example lease

agreement:
First, assume a tenant signs a lease document with the
following terms:
Lease term
The lease begins on April 1, 2016 (commencement date) and
continues for 120 full calendar months. The tenant is
granted access to the premises 60 days prior to the
commencement date to install equipment and furnishings
(the “early access period”). Such access is subject to all the
terms and conditions of this lease, except that the
commencement date and the payment of rent shall not be
triggered thereby.
Tenant improvement allowance
The tenant received a tenant improvement allowance,
or TIA, of $1.2 million from the landlord as an incentive to
sign the lease. The landlord paid the contractor directly for
the construction of the improvements, which were
constructed prior to the early access period.
Moving expenses
The tenant also received a reimbursement of $30,000 for
moving expenses from the landlord.
Base rent
Per the lease document, the first rent payment is due three
full calendar months after the tenant begins operating at the
leased location. Base rent is $205,000/month paid in
arrears; with annual 3% increases on the anniversary of rent
commencement.
Assumptions
Assume the lease is classified as an operating lease and the
fair value of the building is $300 million. Assume the tenant
opened for business at the location on June 1, 2016. Assume
the tenant is a private company with a calendar year-end
and transitioned to ASC 842 on January 1, 2022. Assume
the discount rate implicit in the lease is unknown and the
tenant’s incremental borrowing rate is 6% on September 1,
2016, and 9% on January 1, 2022.
Here are the steps to take to correctly transition the above
lease from ASC 840 to ASC 842 accounting:
Step 1: Determine the lease term
under ASC 840
The lease term stated in the contract is 120 months. The
document also grants the tenant an early access period,
subject to all the terms and conditions in the lease.
Assuming the early access period started on February 1,
2016 – 60 days before the April 1 commencement date – then
under ASC 840 the lease is accounted for beginning on that
date, and the lease term is 122 months: from February 1,
2016, through March 31, 2026.
Note: To understand the difference between the
commencement date, execution date, possession dates,
etc, read this article on when a lease starts.
Step 2: Determine the total lease
payments under GAAP
The tenant will begin paying rent on September 1, 2016 (3
months from the date the tenant opened for business). The
total lease payments are $26,863,751, as illustrated in the
payment schedule below.
Step 3: Prepare the straight-line
amortization schedule under ASC
840
Under ASC 840, the lease term is 122 months (from step 1)
and total rent is $26,863,751 (from step 2). Straight-line
monthly rent expense calculated from base rent is
therefore $220,195 ($26,863,751 divided by 122 months).
The tenant must also account for the total incentive of
$1,230,000 ($1.2 million of tenant improvement allowances +
$30,000 of moving expenses). Under ASC 840, the incentives
are amortized over the lease term on a straight-line basis as
well, resulting in a monthly credit to rent expense
of $10,082 ($1,230,000 / 122 months). As a result of the
incentive adjustment, periodic rent expense on the income
statement is $210,113 ($220,195 – $10,082).
Below is the first 16 months’ straight-line amortization
schedule under ASC 840, showing amortization of both rent
and the incentives.
How is the rent-free period shown on the
amortization schedule
The rent-free period is shown on the amortization table as
seven months of no payment with the periodic straight-line
expense accruing as deferred rent. Below is a summary of
the columns in the amortization table impacted by the free
rent:
 Cash Payment: This is the exact amount paid out each
month.
 Expense: This is the periodic rent expense calculated
from the total payment amount divided evenly over the
number of months in the lease term, also known as
straight-line rent expense.
 Deferred Rent: This is the difference between the
expense incurred and the cash paid. In the first seven
months, the company has free rent so the deferred
rent amount is the total of the expense for the month.
 Deferred Rent Balance: This is the cumulative
difference between the expense incurred and the cash
paid. When the expense is greater than the payment the
balance increases and when the expense is less than
the payment the balance decreases until it is $0 at the
end of the lease term.

Step 4: On the ASC 842 effective

date, determine the total payments
remaining
For calendar-year private companies, the effective date of
ASC 842 was January 1, 2022. The transition entry is
recorded from either the start of the earliest comparative
period presented or if companies utilize the practical
expedient and do not present comparative financial
statements, the transition date.
Most private companies will elect to use the practical
expedient to not present comparative financial statements,
so our example will as well. Therefore, the transition date
for this company is January 1, 2022. The total remaining
payments from January 1, 2022, through March 31, 2026, are
$12,852,672, shown in the updated payment schedule below.

Step 5: Calculate the operating

lease liability
Since the company elected to not present comparative
financials, they must calculate the present value of the
remaining lease payments as of their transition date. ASC
842 requires private entities to use the rate inherent in the
lease, unless that rate is not readily determinable. If the
implicit rate is not determinable, the tenant has the option
to use their incremental borrowing rate or a risk-free rate.
In this example, the tenant uses their January 2022
incremental borrowing rate of 9%, and payments are made
at the end of the month. Using these facts
and LeaseQuery’s present value calculator tool, the present
value of the remaining lease payments is $10,604,260. This
is the lease liability as of January 1, 2022.
Note: The present value amount above ($10,604,260) is a
simplified calculation based on Excel. The number you get
should be lower than this, if you were using more accurate
interest calculations, like those available in some lease
accounting software solutions. Keep this in mind as you’re
viewing demonstrations of lease accounting software from
your choice of vendors.
Step 6: Calculate the right-of-use
asset (with journal entry)
Per ASC 842, the ROU asset is the liability calculated in step
5 above, adjusted by deferred or prepaid rent and lease
incentives. In this example, it is the liability
of $10,604,260 plus the deferred rent balance as of
December 2021, plus the unamortized incentive balance as
of December 2021.
Below is a portion of the table from step 3 for the September
2021 through March 2022 periods to show how we arrive at
the deferred rent balance and unamortized incentive
balance as of December 31, 2021:

The formula for the ROU asset is the lease liability

of $10,604,260 less $1,622,743 (accumulated deferred
rent balance as of December 2021)
less $514,180 (unamortized incentives as of December
2021). This gives us a total ROU asset of $8,467,336. The
journal entry to record the lease liability and ROU asset at
transition clears the outstanding deferred rent and lease
incentive amounts to the ROU asset and would look like
this:
After recording the ROU asset and lease liability as of
transition, the tenant would prepare an amortization
table under ASC 842 to assist with the calculation of the
periodic entries moving forward. Below is the amortization
schedule for the lease in the example as of the transition
date for a private company.

This concludes the example of how to transition an

operating lease from ASC 840 to ASC 842.

Ultimate Lease Accounting

Guide
For more examples of operating leases, finance leases, and
more under ASC 842, download LeaseQuery’s Ultimate
Lease Accounting Guide today.
Capital Lease Accounting
and Finance Lease
Accounting under ASC
842 Explained with a Full
Example
by Rachel Reed, Team Lead, Technical Accounting Consultant | Jan
27, 2023
1. What is a capital/finance lease?

 Finance lease vs. capital lease

2. Capital lease criteria under ASC 840
3. Finance lease criteria under ASC 842
 “Strong-form” vs. “weak-form” finance leases
4. Finance lease accounting example
 Determining finance lease vs. operating lease under
ASC 842
 How to record a finance lease and journal entries

What is a capital/finance
lease?
A capital lease, now referred to as a finance lease
under ASC 842, is a lease with the characteristics of an
owned asset. Under US GAAP, a lessee records the leased
asset for a finance lease as if they purchased it with funding
provided by the lessor.
As a refresher, an operating lease functions much like a
rental agreement; the lessee pays to use the asset but
doesn’t enjoy any of the economic benefits nor incur any of
the risks of ownership.
Finance lease vs. capital lease
Why will capital leases now be referred to as finance
leases? This is one of the changes to lease
accounting under the new lease accounting standards and
the reasoning behind it is simple. The existing nomenclature
of “capital lease” is no longer specific to one lease type
because the majority of leases will now
be capitalized (except those with a term of 12 months or
less at commencement). Hence, the new term, “finance
lease,” is used under ASC 842.

Capital lease criteria under

ASC 840
The capital lease criteria under ASC 840 consisted of four
tests to determine whether a lease was a capital lease or
an operating lease. This assessment was performed when
the lease was signed. The tests included the following:
 1st test – Does the title/ownership transfer to the
lessee at the end of the lease term?
 2nd test – Is there a bargain purchase option?
 3rd test – Is the lease term 75% or more of the
remaining economic life of the asset?
 4th test – Does the present value of the sum of the
lease payments exceed 90% or more of the fair value of
the underlying asset?

ASC 842 provides a practical expedient that, upon

transition, allows a company to retain the lease
classifications for leases that commenced pre-transition.
However, the FASB has indicated that companies electing
this practical expedient must ensure that the accounting
under ASC 840 was appropriate, as this expedient was not
intended to allow accounting errors from previous years to
carry forward uncorrected.

Finance lease criteria under

ASC 842
The way finance leases are treated for lessees has not
changed much. Finance lease obligations are still recorded
on the balance sheet and classified as a liability. The most
significant change is there are now five tests that
determine lease classification instead of four. Another
distinction from the old standards is that the lease
classification test is now performed at lease
commencement instead of when a lease is signed.
ASC 842-10-25-2 provides the lease classification criteria
for lessees:
“A lessee shall classify a lease as a finance lease and a
lessor shall classify a lease as a sales-type lease when the
lease meets any of the following criteria at lease
commencement:
1. The lease transfers ownership of the underlying asset
to the lessee by the end of the lease term.
2. The lease grants the lessee an option to purchase the
underlying asset that the lessee is reasonably certain
to exercise.
3. The lease term is for the major part of the remaining
economic life of the underlying asset. However, if the
commencement date falls at or near the end of the
economic life of the underlying asset, this criterion
shall not be used for purposes of classifying the lease.
4. The present value of the sum of the lease payments
and any residual value guaranteed by the lessee not
already reflected in the lease payments in accordance
with paragraph 842-10-30-5(f) equals or exceeds
substantially all of the fair value of the underlying
asset.
 5. The underlying asset is of such a specialized nature it
is expected to have no alternative use to the lessor at
the end of the lease term.”
Now, let’s walk through each test and understand some of
the distinctions between ASC 840 and ASC 842.
 1st test – Does the title/ownership of the underlying
asset transfer to the lessee at the end of the lease
term?
This test is consistent under ASC 840 and ASC 842.
 2nd test – Does a purchase option exist and is the
lessee reasonably certain to exercise the option?
In contrast to ASC 840, under ASC 842, the existence of a
purchase option does not automatically classify a lease
arrangement as a finance lease. Instead, the criteria is
focused on the lessee’s determination (using economic
factors) of its likelihood to exercise a purchase option
within the agreement. This is inclusive of all purchase
options, not just those considered a bargain.
 3rd test – Is the lease term commensurate with the
major part of the remaining economic life of the asset?
 4th test – Does the present value of the sum of the
lease payments equal or exceed substantially all of the
fair value of the underlying asset?
The specific thresholds or “bright lines” for the third and
fourth tests have been removed under ASC 842. “Major part”
and “substantially all” are not defined under ASC 842.
However, ASC 842-10-55-2 provides guidance that the 75%
threshold represents a “major part” of remaining economic
life of the underlying asset and the 90% threshold
represents “substantially all” of the fair value of the
underlying asset.
It’s important for your company to establish its own
thresholds for these tests, document them in an internal
accounting policy, and follow them consistently. In our
experience, most LeaseQuery clients have chosen to keep
the existing thresholds of 75% and 90%, respectively, for
continuity purposes.
  New 5th test – Is the asset so specialized in nature it
provides no alternative use to the lessor once the lease
is complete?
The fifth test was added in ASC 842. However, typically, we
notice if a lease triggers the fifth test, it’s likely that it also
triggered the third or fourth test. This is because, for
example, a shrewd landlord factors in the future use of the
asset when establishing the lease payments, and as such,
typically the fourth test would be triggered.

“Strong-form” vs. “weak-form”

finance leases
At LeaseQuery, when finance leases meet either the first or
second criterion, we refer to them as “strong-form” finance
leases. We refer to those meeting only the third, fourth, or
fifth criterion as “weak-form” finance leases. This is an
important distinction because there is one major difference
between these two types. For finance leases that transfer
ownership at the end of the lease term or for those that
contain a lease purchase option, I.e. strong-form finance
leases, the underlying assets are amortized over the asset’s
useful life, as if the asset were owned. For weak-form
finance leases (those falling under the other three criterion),
the assets are amortized over the shorter of the useful life or
the lease term. The difference is subtle, but it has
accounting implications.

Finance lease accounting

example
In this section, we’ll explain finance lease accounting under
ASC 842 using an example.
Assume a company (lessee) signs a lease for a forklift with
the following information:
 Fair value: $16,000
 Lease term: 3 years
 Base rent: $450 month paid in advance
 Useful life of the forklift: 5 years
  Purchase option: At the end of the lease term, the
company can purchase the forklift for $1,000, which is
the estimated fair value at the end of the lease.
 Discount rate: A bank would charge the lessee 4% for a
$16,200 loan over 3 years
 The company has no plans to purchase the forklift

Determining finance lease vs.

operating lease under ASC 842
To determine if the lease is a finance lease or an operating
lease, the company performs the finance versus operating
lease analysis using the five criteria laid out under Topic
842. If the lease meets any of the following five criteria,
then it is a finance lease.
Criteria 1: Does the title of the underlying asset transfer to
the lessee at the end of the lease term?
Title of the underlying asset does not transfer to the lessee
at lease end, so the first test for finance lease accounting is
not met.
Criteria 2: Does the lease contain a purchase option the
lessee is reasonably certain to exercise?
The lessee does not plan to exercise the purchase option,
so the second test for finance lease accounting is not met.
Criteria 3: Is the lease term greater than or equal to the
major part of the remaining useful life of the asset? (Note:
This company has maintained the greater than or equal to
75% threshold for this test).
The lease term is 3 years while the remaining useful life of
the forklift is 5 years. 3 years is less than 75% of 5 years
( 3.75 years), so the third test for finance lease accounting
is not met.
Criteria 4: Is the present value of the sum of the lease
payments substantially all of the fair value of the leased
asset? (Note: This company has maintained the greater than
or equal to 90% threshold for this test).
See below where we discuss the analysis of this fourth test.
Criteria 5: Is the underlying asset of such a specialized
nature it is expected to have no alternative use to the lessor
at the end of the lease term?
The fifth test is not applicable to this lease.
To perform the fourth test, the lessee calculates the present
value of the remaining lease payments. In this example, take
the present value of the monthly payments of $450 over 3
years at 4%.
Download our free present value calculator to perform the
calculation. Using this tool, we calculate a present value of
$15,293 which is greater than 90% of the fair value of the
asset (90% of $16,000 is $14,400). This lessee has chosen to
utilize the 90% threshold to represent “substantially all” of
the fair value of the asset. As a result, this lease is
classified as a finance lease per the fourth test.

The following is the lease amortization schedule, prepared

with the effective interest method, used to record the
journal entries under finance lease accounting (rounded to
the nearest whole dollar):
How to record a finance lease and
journal entries
We now have all the information we need to record the
initial journal entry. As documented above, the present value
of the minimum lease payments is $15,293, so the initial
journal entry to record the finance lease at lease
commencement is:

In the first month, two entries are recorded: one to record

the payment of the lease and a second to
record amortization expense. The periodic cash payment is
split between the following:
1. interest expense on the finance lease liability
2. the finance lease liability reduction
These numbers are easily obtained from the amortization
schedule above.

Because this is a “weak-form” finance lease, it’s amortized

over the lease term of 3 years (36 months). The following
journal entry represents the entry for amortization expense,
which will not change throughout the lease:

Journal entries in subsequent months will be similar to the

first month’s entries. The payment will be allocated between
lease liability and interest expense and amortization
expense will be recognized.

IFRS 16
IFRS 16 is the new international lease accounting standard.
This pronouncement also requires lessees to recognize a
lease liability calculated as the present value of the
expected lease payments and a related ROU asset. An
additional change in the IFRS guidance is that all leases will
be classified as finance leases, which differs from US GAAP.
This single model approach eliminates the operating lease
classification for lessees under IFRS. The standard’s
effective date was January 1, 2019.
While the lessee model for IFRS 16 is a single model
approach, for lessors the operating and finance
classification model continues. Lessors are required to
determine if a lease is classified as an operating or finance
lease and use the appropriate accounting treatment.
The main driver between operating and finance leases for
lessors under IFRS 16 is transfer of ownership. Lease
agreements where the lessor maintains ownership are
operating leases. For operating leases, the lessor continues
depreciating the leased asset and records the incoming
lease receipts as revenue on a straight-line basis over the
lease term.

When the lease agreement is classified as a finance lease,

the lessor will calculate the net investment in the lease
using the present value of future expected lease receipts
and record this amount as a receivable. Lessors are also
required to derecognize the carrying value of the underlying
asset. Any difference between the net investment in the
lease and the carrying value of the underlying asset is
recognized as a gain or loss on the income statement.
IFRS 16 Leases:
Summary, Example,
Journal Entries, and
Disclosures
by Abdi Ali, Sr. Technical Accounting Manager | Feb 6, 2021
1. IFRS 16 summary

 IFRS 16 leases
What is considered a lease under IFRS 16?
2. IFRS 16 finance lease example (lessee)
 Amortization schedule
Journal entries
3. IFRS 16 disclosures
4. Summary

IFRS 16 summary
Companies previously following the lease
accounting guidance under IAS 17 likely transitioned
to IFRS 16 during their 2019 fiscal year, in accordance with
the standard’s effective date of January 1, 2019, for annual
reporting periods beginning on or after that date. Therefore,
the standard is now effective for all organizations following
international accounting standards.
This article will walk through the key changes between
the lessee accounting model under IAS 17 and IFRS 16 and
also provide a comprehensive example of lessee accounting
under IFRS 16. The lessor accounting model under IFRS 16
remains relatively unchanged from IAS 17 and will not be
covered in this article.
Note: This article has been updated for the benefit of
organizations who have already transitioned to IFRS
16. Click here to read or download the previous version of
this article, which includes two transition examples.
IFRS 16 leases
Within the lessee accounting model under IFRS 16, there is
no longer a classification distinction between operating and
finance leases. Rather, now a single model approach exists
whereby all lessee leases post-adoption are reported as
finance leases. These leases are capitalized and presented
on the balance sheet as both assets, known as the right-of-
use (ROU) asset, and liabilities, unless subject to any of the
exemptions prescribed by the standard.
Similar to finance lease accounting under IAS 17, the
accounting treatment for finance leases under IFRS 16
results in the recognition of both depreciation and interest
expense on the income statement. For those entities dually
reporting under both IFRS 16 and ASC 842, you will notice
that the accounting for finance leases under IFRS 16
resembles the accounting for finance leases under ASC 842.
However, ASC 842 still retains the operating lease
classification.
In conjunction with the change in the lessee’s financial
statement presentation, IFRS 16 also requires more robust
disclosures.

What is considered a lease under

IFRS 16?
Under IFRS 16, a lease is defined as a contract granting an
entity the right to utilize a specific asset for a prescribed
period of time in exchange for agreed-upon consideration.
To determine whether a contract grants control of the asset
to the lessee, the agreement must provide the following to
the lessee:
1. The right to substantially all economic benefits from
the use of the asset
2. The right to dictate how the asset is used by the entity
At times, an organization may have a contract that seems to
meet the definition of a lease but does not fall within the
scope of IFRS 16. Situations where this may occur include
but are not limited to:
1. Leases of biological assets
2. Leases for the exploration of non-regenerative
resources such as oil, gas, etc.
3. Service concession arrangements
4. Licenses of intellectual property
Concurrently, lessees reporting under IFRS 16 may choose
to take advantage of practical expedients that exclude
certain types of leases from capitalization. These include:
1. Short-term leases, defined as having a term of 12
months or less at commencement and no option to
purchase the leased asset
2. Leases of low-value assets, defined as leases for which
the underlying asset’s fair value (when the asset is
new) is generally less than $5,000
Note: Please refer to our blog on practical expedients for
more details on IFRS 16 expedients

IFRS 16 finance lease

example
Since the majority of entities reporting under IFRS have
already adopted IFRS 16, we will bypass a discussion of the
various adoption methods and jump right into the
accounting. For a breakdown of different adoption methods,
please refer to our IFRS 16 detailed walkthrough.
In the example below, we’ll outline the steps to calculate
the lessee’s opening lease liability and ROU asset and
present the complete amortization schedule, followed by the
initial transition journal entry and the journal entry for the
first period’s activity.
Commencement Date: January 1, 2021
Lease Term: 10 years
Lease Payment (paid in arrears): $10,000 annually
Lessee’s Incremental Borrowing Rate: 6%
Useful Life of Underlying Asset: 25 years
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Amortization schedule
Based on the facts above, we’ll take the following steps to
generate the IFRS 16 amortization schedule:
1. Calculate the initial lease liability as the present value
of the total remaining lease payments as of the
commencement date.
2. Calculate the initial right-of-use asset as the lease
liability at commencement plus or minus any necessary
adjustments.
3. Amortize the lease liability over the lease term to
reflect both lease payments and interest on the liability
using the effective interest method.
4. Depreciate the ROU asset in a systematic and rational
manner over the useful life of the underlying asset or
the lease term, whichever is shorter.
Using the values noted above, the amortization schedule at
the commencement date of the lease is as follows:
To calculate the present value of the future lease
payments, apply the lessee’s incremental borrowing rate of
6%. Per IFRS 16, lessees are encouraged to use the rate
implicit in their lease. However, if that is not readily
determinable, then a lessee is provided further leeway to
use their incremental borrowing rate as we have done in this
example.
As we can see in the above schedule, because no
adjustments were necessary to calculate the opening ROU
asset at commencement, the ROU asset is equal to the
lease liability. Thereafter the ROU asset is depreciated in a
systematic and rational manner (e.g. straight-line in our
case) over the lesser of the lease term or useful life of the
underlying asset. In our example, the ROU asset is
depreciated over the 10-year lease term, which is shorter
than the leased asset’s useful life of 25 years.

Journal entries
The initial journal entry under IFRS 16 records the asset and
liability on the balance sheet as of the lease commencement
date. Below we present the entry recorded as of 1/1/2021 for
our example:
 U
tilizing the amortization table, the journal entry for the end
of the first period is as follows:

IFRS 16 disclosures
Now let’s cover the disclosure requirements for lessees
under IFRS 16. Within the notes to the financial statements,
an entity is expected to present both qualitative and
quantitative disclosures regarding their leasing activities for
the respective reporting period(s). The quantitative
disclosures required by IFRS 16 for lessees include but are
not limited to:
 The carrying amount of all ROU assets summarized by
asset class as of the end of the reporting period
 ROU asset depreciation expense, summarized by asset
class for the reporting period
 Total interest expense on lease liabilities for the
reporting period
 Expenses from short-term leases not included on the
balance sheet as of the end of the reporting period
 Expenses from low-value asset leases not included on
the balance sheet as of the end of the reporting period
or in the expense summary of short-term leases for the
reporting period
 Expenses from variable lease payments excluded from
the lease liability calculation
 Sublease income for the reporting period
 Any gains or losses recognized from sale-leaseback
transactions
  Total cash outflows for leases
 Any ROU asset additions
 A maturity analysis of all lease liabilities as of the end
of the period
Furthermore, the lessee is required to disclose certain
qualitative information to help financial statement users
understand the entity’s leases and leasing activities,
including the following:
 Summary of leasing activities
 Commitments for leases not yet commenced (i.e. a
liability is not yet recorded on the balance sheet)

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Summary
This concludes our high-level overview of IFRS 16. We
introduced the key differences for lessee accounting under
IAS 17 and IFRS 16, provided an example of a lessee
amortization schedule and the related journal entries, and
discussed the required disclosures.

Depreciation vs. Amortization: Comparison Chart

Depreciation vs Amortization
Summary

Mathematically speaking, depreciation and amortization are

basically the same things and even philosophically, they are not
very different. The idea behind these two is to instead of
expensing these expenses, spread out the expense over their
useful life. The difference between the two is that depreciation
is when you have physical assets such as a car, property,
building, machinery, or any tangible asset. Amortization,
however, is when you have non-physical assets, something less
tangible like licenses, copyright, agreements, and software. If
you have intangible assets, you would simply amortize it
instead of depreciate it.

What are two types of amortization?

Amortization mainly refers to two types of situations: when

paying off debt payments in regular intervals and for long-term
loans like mortgage, and distribution of non-physical assets
over a set period of time.

How do you calculate depreciation and amortization?

Depreciation is calculated by subtracting the asset’s resale value

from its original cost. Amortization is the paying off debt
payments over time till loan principle reduces to zero.

What are three different methods of amortization?

The three common amortization methods are straight line,
declining balance, and annuity.

Read more: Difference Between Depreciation and Amortization

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