Lease accounting is a crucial part of any accounting system; companies must ensure they handle these agreements properly to avoid accounting improprieties. IFRS lease accounting has a few significant differences from other national accounting standards used by companies. Under lease accounting, companies must first determine if the lease is capital or operating, the separation of land and buildings, and amortization of sales and leasebacks. Other requirements may exist when a company engages in a lease and must use IFRS lease accounting. Each situation may be different, so a company must carefully look at each individual lease.
The two lease classifications under IFRS lease accounting are operating and capital. Under current rules, a lease is considered a capital lease if it meets one of four conditions. The conditions are these: Lease life is 75 percent of the asset’s life, asset ownership transfers at lease end, and there is a bargain price for purchasing the asset at lease end, or the present value of lease payments are more than 90 percent of the asset’s fair market value. When a lease fails to meet any of these conditions, the company must then classify the lease as operating. The IFRS lease accounting rules are different for each of these classifications.
Another major difference between IFRS lease accounting and other national accounting standards — such as generally accepted accounting principles — is the separation of land and buildings. IFRS mandates the separation for these two items under current lease accounting rules. Again, a company must first determine if the lease is capital or operating and then create separate accounts for the buildings and land involved in the lease. The result is two separate accounts that a company needs to review in order to account for them properly under IFRS lease accounting rules. Failure to properly separate these items under lease accounting rules can result in penalties from legal authorities.
A sales and leaseback agreement is another important difference between IFRS lease accounting rules and other national accounting standards. Under this agreement, a company sells an asset and then leases the item back from the purchaser. Here, the lease typically has classification as either a finance or operating lease, with the former transferring risks and rewards to the lessee. If the lease is a finance lease, IFRS lease accounting rules dictate amortization for the gain on the sales and leaseback transaction. If it is an operating sales and leaseback, then the company must recognize the gain immediately.