Define Which Leases Are To Be Capitalized On The Lessee’s Ba

Define Which Leases Are To Be Capitalized On The Lessees Ba

Question 1 Define which leases are to be capitalized on the lessee’s balance sheet under IFRS 16. Explain how this is different from the criteria that was previously used in U.S. GAAP (see Wiley 2ed Chapter 21 and ASC 840). Also, explain which industries are most likely affected by this change and why. Question 2 In one paragraph, explain why you think that the FASB voted to defer the effective date of the proposed ASC 842. Question 3 In lease accounting, the FASB and IASB define a lease relative to a contractual “right of use†(ROU) of an asset. Define ROU. Is this ROU model consistent with the IASB and/or FASB Conceptual frameworks? Explain your answers in one or two paragraph(s) .

Paper For Above instruction

Lease accounting standards have undergone significant changes, particularly with the adoption of IFRS 16 and updates to U.S. GAAP. Under IFRS 16, a lease is defined as a contract that conveys the right to control the use of an identified asset for a period in exchange for consideration. This definition emphasizes the control over the use of the asset rather than legal ownership or specified criteria such as lease term or payment structure. Consequently, leases that meet this control criterion are required to be recognized on the lessee’s balance sheet as a Right of Use (ROU) asset and a corresponding lease liability, regardless of whether the lease is classified as operating or finance under previous standards. This contrasts with earlier U.S. GAAP (ASC 840), where operating leases were effectively kept off the balance sheet, with capitalization only applying to finance leases that transferred substantially all the risks and rewards of ownership. ASC 840 used specific criteria such as lease term exceeding 75% of the economic life of the asset or present value of lease payments surpassing a certain threshold to classify leases as capitalize or operating, leading to less uniformity and less transparency for lessees.

The key difference between IFRS 16 and prior U.S. GAAP standards lies in the scope of leases that require capitalization. IFRS 16 mandates the recognition of almost all leases on the balance sheet, thereby increasing transparency and comparability across firms and industries. This change primarily affects industries with significant leasing activities, such as retail, airlines, and shipping, where companies have traditionally used operating leases to keep liabilities off their balance sheets. For instance, retail companies lease numerous stores and equipment, and airlines lease aircrafts; under IFRS 16, these commitments are now reflected on the financial statements, providing a clearer picture of leverage and financial obligations.

The FASB’s decision to defer the effective date of ASC 842 reflected a recognition of the complexity and implementation challenges faced by companies, especially smaller entities or those with extensive leasing portfolios. The deferment allows organizations additional time to adapt their systems, processes, and disclosures to comply with the new standards. Many industry stakeholders argued that immediate implementation could result in significant operational disruptions and inaccuracies in financial reporting, which could mislead investors. Furthermore, the global economic uncertainties and differing degrees of readiness across sectors prompted the FASB to provide this relief, ensuring that entities can transition more smoothly to the new leasing standards without compromising the quality and accuracy of financial informasjon.

The concept of the Right of Use (ROU) is central to lease accounting under IFRS 16 and ASC 842. ROU represents the lessee’s contractual right to control the use of an identified underlying asset during the lease term in exchange for lease payments. The lessee gains control over the use of the asset rather than ownership, which is reflected through recognizing a ROU asset and a corresponding lease liability on the balance sheet. The ROU model aligns with the conceptual frameworks of both the IASB and FASB, which emphasize control and the economic substance of transactions. According to the IASB Conceptual Framework, an asset is a resource controlled by an entity from which future economic benefits are expected to flow. Similarly, the FASB Framework defines an asset as a present right that results from past transactions or events, giving control over future benefits. Therefore, the ROU model is consistent with these frameworks because it captures the right to control and use an identified asset during the lease term, representing an economic resource controlled by the lessee. This focus on control and the transfer of rights underpins the consistency of the ROU model with the core principles of the IASB and FASB conceptual structures.

References

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• FASB. (2016). Accounting Standards Update No. 2016-02: Leases (Topic 842). Financial Accounting Standards Board.
• IASB. (2016). IFRS 16: Leases. International Accounting Standards Board.
• Wiley. (2015). Wiley Not-for-Profit GAAP 2015. John Wiley & Sons.
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