How leases are recognized and measured under IFRS 16 and ASC 842

Graziano Stefanelli
7 minutes ago
5 min read

Leases represent agreements granting the right to use an asset for a period of time in exchange for consideration. Both IFRS 16 (Leases) and ASC 842 (Leases) require lessees to recognize almost all leases on the balance sheet, removing the traditional distinction between “finance” and “operating” leases for lessees. The result is greater transparency about leasing obligations and the impact on leverage and cash flow.

While the core principle—recording a right-of-use (ROU) asset and a lease liability—is shared, differences remain in recognition exemptions, measurement of expenses, and lessor classification.

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How leases are identified.

A contract contains a lease if:

It conveys the right to control the use of an identified asset.
The customer obtains substantially all economic benefits from its use.
The customer directs how and for what purpose the asset is used.

Examples of identified assets: a specific vehicle, office space, or equipment.Substitution rights held by the lessor can negate lease identification if they are substantive (the lessor can easily replace the asset).

Scope exclusions (both standards):

Biological assets (IAS 41).
Intangible assets (e.g., software licenses).
Exploration rights for minerals or oil.
Service contracts with no right to control an asset.

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Initial recognition under IFRS 16.

1) Lessee accounting. At commencement, the lessee recognizes:

Right-of-use (ROU) asset — representing the right to use the asset.
Lease liability — representing the obligation to make lease payments.

Measurement:

Lease liability = PV of lease payments over term, discounted at interest rate implicit in the lease or lessee’s incremental borrowing rate.
ROU asset = Lease liability + initial direct costs + prepayments − lease incentives.

Example (IFRS 16):Lease term: 5 years; annual payment 100,000; discount rate 5%.PV of payments = 432,950.Entry at commencement:

Debit: ROU Asset 432,950
Credit: Lease Liability 432,950

Subsequent accounting:

Depreciate ROU asset (straight-line over term).
Recognize interest on liability using effective interest method.

Year 1 entries:

Debit: Depreciation Expense 86,590
Debit: Interest Expense 21,650
Credit: Lease Liability 100,000
Credit: Cash 100,000

Low-value and short-term exemptions:IFRS 16 permits not recognizing leases shorter than 12 months or of low-value assets (<USD 5,000), expensing payments directly to P&L.

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Initial recognition under US GAAP (ASC 842).

1) Lessee classification.ASC 842 retains two types of leases:

Finance lease (formerly capital lease): transfers control of underlying asset.
Operating lease: does not transfer ownership but still recognized on balance sheet.

2) Initial recognition for both.Both record ROU asset and lease liability at the PV of lease payments.

3) Expense recognition differs.

Finance lease: separate recognition of interest and amortization (like IFRS).
Operating lease: single straight-line lease expense, though both ROU asset and liability still recognized.

Example – operating lease:PV of lease payments = 432,950.Entry:

Debit: ROU Asset 432,950
Credit: Lease Liability 432,950

Each year recognize total lease cost (interest + amortization combined) evenly over term.

4) Short-term leases (≤12 months):May be expensed directly, similar to IFRS exemption.

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Lessor accounting under both frameworks.

1) IFRS 16 lessor model:Retains finance lease and operating lease classification.

Finance lease: recognize receivable = net investment in lease.
Operating lease: keep asset on balance sheet; recognize income on straight-line basis.

2) ASC 842 lessor model:Same dual classification, with added sales-type lease (for manufacturers/sellers).

Recognize selling profit/loss upfront if control transfers.
Operating lease income recognized over time.

Example – lessor finance lease (IFRS 16):Gross investment = 500,000; PV of lease payments = 450,000; residual = 50,000.

Debit: Lease Receivable 450,000
Credit: Lease Asset 450,000

Interest income recognized over the term using effective interest rate.

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Comparative table: IFRS 16 vs ASC 842.

Aspect	IFRS 16	US GAAP (ASC 842)
Lessee classification	Single model (all on-balance-sheet)	Dual model (finance and operating)
Expense recognition	Depreciation + interest	Finance: same; Operating: single expense
Low-value asset exemption	Yes (<USD 5,000)	No explicit threshold
Short-term lease exemption	Yes (≤12 months)	Yes (≤12 months)
Discount rate	Implicit or incremental borrowing rate	Same
Lessor accounting	Finance / Operating	Finance / Sales-type / Operating
Sale-leaseback accounting	Based on IFRS 15 control transfer	Based on ASC 606 control transfer
Variable lease payments	Excluded from liability if dependent on usage	Same principle

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Example — lease amortization schedule (IFRS 16 / ASC 842 finance).

Year	Opening Liability (USD)	Interest (5%)	Payment	Closing Liability (USD)
1	432,950	21,650	(100,000)	354,600
2	354,600	17,730	(100,000)	272,330
3	272,330	13,620	(100,000)	185,950
4	185,950	9,300	(100,000)	95,250
5	95,250	4,760	(100,000)	—

Total interest expense: 67,060Total cash payments: 500,000

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Sale and leaseback transactions.

When an entity sells an asset and leases it back:

If the transfer qualifies as a sale under IFRS 15/ASC 606, recognize the sale and a new ROU asset.
Measure ROU asset as proportion of previous carrying amount retained for use.
Gain or loss recognized only on rights transferred to buyer-lessor.

Example:Asset cost 1,000,000; carrying amount 600,000; sale price 900,000; 5-year leaseback covers 40% of use.Recognize gain = 60% × (900,000 − 600,000) = 180,000.

Entry:

Debit: Cash 900,000
Credit: Asset 600,000
Credit: ROU Asset 240,000
Credit: Gain on Sale 180,000

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Disclosures required.

Lessee disclosures (IFRS 16 / ASC 842):

Breakdown of lease liabilities by maturity.
Depreciation of ROU assets and interest expense.
Expense for short-term and variable leases.
Weighted-average discount rate and lease term.

Lessor disclosures:

Maturity analysis of lease receivables.
Income from lease contracts (interest, variable rent).
Risk management policies for residual values.

Example disclosure excerpt:

Item	Amount (USD)
ROU Assets – Buildings	2,400,000
Lease Liabilities (current + noncurrent)	2,450,000
Depreciation Expense	480,000
Interest Expense	120,000
Short-Term Lease Expense	50,000

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Journal entries summary.

1) At commencement:

Debit: ROU Asset xx
Credit: Lease Liability xx

2) Lease payment:

Debit: Interest Expense xx
Debit: Lease Liability (principal) xx
Credit: Cash xx

3) Depreciation (IFRS or finance lease):

Debit: Depreciation Expense xx
Credit: Accumulated Depreciation – ROU Asset xx

4) Operating lease expense (GAAP):

Debit: Lease Expense xx
Credit: Cash xx

5) Reassessment of term or payments:

Debit/Credit: ROU Asset xx
Debit/Credit: Lease Liability xx

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Impact on financial performance and ratios.

The adoption of IFRS 16 and ASC 842 increases reported assets and liabilities, affecting leverage and profitability metrics:

EBITDA: increases (since lease expense replaced by depreciation + interest).
Debt-to-equity ratio: rises due to new liabilities.
ROA: decreases because of higher total assets.
Operating cash flows: improve, as interest portion classified as financing.

Analysts adjust for lease capitalization effects to compare pre- and post-standard results consistently.

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Operational considerations.

To apply IFRS 16 and ASC 842 effectively:

Maintain an accurate lease register within ERP systems.
Periodically reassess discount rates and lease terms (options to renew or terminate).
Track modifications, reassessments, and variable payments.
Coordinate with procurement and treasury to align leasing and financing strategies.

Proper implementation enhances transparency in capital structure analysis and ensures compliance with modern leasing disclosure requirements.

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DATA STUDIOS

.....[datastudios.org]