Lease Accounting
Lease is an agreement between two parties whereby the owner of the asset, known as Lessor, allows the lessee to use his asset for contractual time period in return of fixed periodic payments.
In terms of accounting treatment; Leases are of two types:
- Finance Lease
- Operating Lease
A Finance lease is generally executed with an equal borrowing amount for purchase of an asset. Thus, since the asset is borrowed with a debt, an equal amount is added on asset and liability side of company’s balance sheet. Over the years, for the asset recorded in the balance sheet, company charges depreciation expenses on the asset and interest expense on the liability amount.
Unlike finance lease, operating lease is treated as a rental agreement between lessor and lessee. Unlike, finance lease, no asset or laibility is reported in the balalnce sheet and lessee only recognizes the rental expenses in the income statement which he is obligated to pay for using the asset of the lessor.
Lease Accounting under IFRS and GAAP Accounting standards:
Lessee’s Perspective under IFRS:
Under IFRS, the classification of a lease is determined by the economic substance of the transaction. If under the lease agreement, lessor transfers all the rights and risks of ownership to lessee, the lease is treated as finance lease. IFRS declares the situation for lease to be treated as financing lease:
- If at the end of lease period, title of ownership is transfered to the lesse by lessor.
- The lease agreement allows the lesse to purchase the leased asset for a price that is olwer than the fair market value of th eleased asset.
- A major portion of asset’s economic life is covered in the lease term(period) of use of asset.
- The present value of the lease payments is equal to fair value of the leased asset.
- The specifications or use of leased asset is so specialized that only the cocnered lessee can use such asset and that too without any significant modifications.
Lessee’s Reporting Perspective under GAAP:
Under US GAAP, the criteria are conceptually similar, but are more specific than IFRS. A lessee must treat a lease as a finance lease if any of the following criteria is met:
- If at the end of lease period, title of ownership is transfered to the lessee by lessor.
- Lease agreement contains the bargain purchase option which permits the lessee to purchase the leased asset at price lower than fair market value of the asset at some future date.
- The lease period is 75% or more of the asset’s economic life.
- The present value of the lease payments accounts for atleast 90% of current fair market value of the leased asset.
** Thus lease agreement which do not meet any of these conditions is classified as an operating lease. However, whether the entity is following GAAP or IFRS Accounting standards, lessee company always prefer operating lease as it do not create any liability for the company.
Lessor’s Perspective:
Even from the perspective of lessor, the leases are treated to be operating lease or a financing lease too. But still even in this perspective, there are differences in IFRS and GAAP.
Under IFRS, classification by the lessor is the same as the lessee i.e if all the rights and risks of ownership are duly transfered to the lessess, in that case the lease is accounted as financing lease else it is treated to be an operating lease.
Under US GAAP, if any one of the capital lease as described for the lessee above, is met, along with reasonable assurance of collectibility of lease payments, the lessor must treat the lease as a capital lease else it will be accounted as operating lease.
Answer 2)
Infosys Limited follows IFRS while prepraing its financial statements and even in US, while filing SEC reports, company confirms its reports as per IFRS reporting standards.
However, the counterpart company Cognizant which is also registered in US, follows GAAP accounting standards while filing SEC reports.
Answer 3)
IFRS is the primary accounting standard which is set by International Accounting Standards Baord(IASB). Before the introduction of IFRS, every country had its own accounting standard which made it difficult for the cross-country analyst to compare the companies and their financial performances. Thus, introduction of IFRS was a high requirement for the companies to adopt. Although, at present IFRS is being used by organizations globally but still the companies in US and European Union are using US GAAP Accounting standards.
Since 2002, there have been continued discussion on convergence of US GAAP and IFRS with the objective of comoing up with high quality accounting standards but nothing has been materialized yet.
b) One similarity under US GAAP and IFRS reporting is that both the accounting standards require companies to prepare there accounting standards according to accrual basis.However, there are many dis-similarities between IFRS and GAAP accounting standards. For Instance, LIFO inventory system is not allowed in IFRS accounting standards while the same is allowed in US GAAP.
Works Cited
Robinson, Thomas. "Financial Reporting Standards." Institute, CFA. Financial Reporting and Analysis. Boston: Custom, 2011. 33-58. Print.
Robinson, Thomas. "Long Lived Assets." Institute, CFA. Financial Reporting and Analysis. Boston: Custom, 2011. 101-134. Print.
