Free Research Paper On United States GAAP/IFRS Paper
Introduction. Many accounting issues are addressed by IFRS and US GAAP from different perspectives, with the US GAAP approach traditionally being rule-based and that of IFRS principle-based. The process of reconciling the differences often appears difficult, given different starting points, regulatory environments and financial reporting objectives. The story of work over the new FASB\IASB joint standard on leases aimed at replacing current International Accounting Standard (IAS) 17 is one of the examples of such differences.
Leases: similarities and differences under the current model. The major discrepancies in leases treatment between US GAAP and IFRS have evolved in the last decade. The current model of US GAAP implies classification test application under the current Financial Accounting Standard (FAS) No. 13 (1976) to define whether the lease meets criteria for capitalization or should be classified as operating. The criteria for capital lease recognition are similar to International Accounting Standard No.17 (Leases) (1997). These are the transfer of ownership to the lessee at the end of the lease term and reasonable expectation that purchase option will be exercised at inception. The principles of recording both finance lease (separate recognition of the asset and liability) and operating lease (recognizing expenses on straight-line basis over the lease term) are also similar (IASB).
As the IASB\FASB convergence project emerged, the Proposed Accounting Standard Update (Topic 840) appeared in the FASB's new Accounting Standards Codification in 2010. Lessor accounting under Topic 840 and IAS 17 was using the same tests to determine whether a lease is a purchase in installments (finance lease), or an operating lease, with US GAAP having two additional criteria for the lease qualifying as finance lease, compared to IFRS (FASB, IASB).These were reasonable expectation of lease payment collection and absence of important uncertainties regarding the amount of unreimbursable costs to be incurred by the lessor. Per EY 2011 analysis, significant differences were related rather to separate elements of lease or arrangement types than to recognition and measurement concepts on the whole (EY, 30). To account for the land and building as a single unit or separately, 25% test was applied to the fair value of the land at inception (out of total fair value of lease) by US GAAP. Gain or loss on operating sale and leaseback was deferred and amortized over the lease term while it was recognised immediately in profit and loss per IAS 17(IASB). Other minor differences included in EY report were terminology discrepancies (leveraged lease by a lessor under Topic 840, absent in IAS 17), separate types of leases (real estate\land) treatment and the rate used to discount minimum lease payments to the present value (EY, 31).
The conceptual differences started to emerge in course of working over the new FASB\IASB joint standard on leases (Deloitte). The idea of a new standard appeared due to the current standards’critique for the lack of consistency in reporting (possibilities for similar transactions to be reported in a different way) and significant amounts of off balance-sheet finance not being recognized. The project was initiated in 2006, with subsequent publication of several exposure drafts and years of deliberations. Though these have reconciled the issues related to the classification of leases and sale and leaseback transactions, the different lessee accounting models adopted by FASB and IASB in 2014 became their dark side (Deloitte).
Leases: scope of the new standard. If variations in the terms and substance of leases (sale-leasebacks, vendor financing arrangements) were an issue where both boards agreed on the need of one approach to provide a faithful representation of leasing transactions, the single accounting model became a problem. In 2009, IASB proposed such a model for all lease contracts, with a removal of the requirement for lessees to classify them as finance or operating leases (IASB). The recognition and measurement criteria for this model were debated for several years, with IASB arguing that small assets for lessees should be exempted from the requirement to appear on the company balance sheet. Finally, the recognition and measurement exemption for the lessee’s leases shorter than 12 months appeared. The right-of-use concept, similar to the current US GAAP concept for lease accounting, was accepted in 2013 to present leases on balance sheets for both US GAAP and IFRS. The determination whether a lease is an installment purchase or not, split the leases into Type A and Type B. For both types, a lease agreement would create the lessee’s recognition of right-of-use asset and lease liability based on current value of lease payments under the contract. The concept was accepted by both FASB and IASB as it presented the information in a way useful for decision-makers. Thus, from the balance sheet perspective a new converged approach was created: to present right-of-use asset and lease liability separately, on gross basis (FASB).
However, the income statement perspective of leases accounting treatment posed significant challenges to both boards. Since 2013, FASB has been advocating the dual-model approach to bringing leases on income statement as type A for majority of finance leases and as type B for majority of operating leases. For Type A leases, companies continue to recognize and present the interest on lease liablility separately from amortized payments for the right to use the asset. For Type B leases, companies recognize a single lease cost for both the asset amortization on a straight-line basis and the interest on lease liabilility. This could significantly mitigate the front-loading of profit or loss for certain types of leases (FASB).
On the contrary, IASB was insisting on single approach for lessees to create a model easy to understand (Deloitte). In fact it was recognizing all the leases as Type A which by FASB opinion would distort the substance of the transaction for the lessee. Such recognition was stated by FASB to create unwanted economic effects together with unjustified increase of costs for presentation and disclosure. US GAAP does not treat every lease as installment purchase therefore the income statement effect of the model was not acceptable for FASB due to 'front-loading' to profit or loss. This is created by the combination of both decreasing interest charge (in line with lease liability repayment) and the straight-line amortization of the asset. The series of deliberations between FASB and IASB have not resolved the problem, and redeliberations are expected in the first half of 2015. So far, the two boards still decided to have different lessee accounting models (Deloitte).
Conclusion. Based on FAS No.13 and IAS 17, lease accounting in US GAAP and IFRS had several differences related to lease terminology and certain types of leasing arrangements treatment, as well as additional criteria for finance lease recognition and 25% test application to account for land and building lease. However, in course of FASB\IASB joint project on leases the minor differences such as terminology and sale and leaseback accounting have been reconciled, and more serious conceptual discrepancies have appeared. Though supporting the same accounting approach from balance sheet perspective, US GAAP and IFRS disagree on lessee’s treatment of finance and operating leases in income statement, with IASB advocating front-loading of the cumulative amounts of interest charges and assets amortization for all leases types, and FASB distinguishing between Type A (finance) and Type B(operating) leases treatments. Redeliberations are expected in attempt to resolve the issue of assessment of the same accounting concept from dramatically different perspectives.
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Deloitte Global Services Limited (Deloitte).”Leases”. IAS Plus, n.d. Web. 11 March 2015. ‹http://www.iasplus.com/en/projects/major/leases›.
Financial Accounting Standards Board (FASB). “Statement of Financial Accounting Standards (FAS) No.13.” FASB, Nov.1976. Web.11 March 2015. ‹http://www.fasb.org/ ›.
Financial Accounting Standards Board (FASB). “Proposed Accounting Standards Update. Exposure Draft, Leases (Topic 840)” FASB, 17 Aug 2010.Web. 11 March 2015. ‹http://www.fasb.org/ ›.
International Accounting Standards Board (IASB). “International Accounting Standard No.17 (IAS 17) - Leases” IFRS, Dec. 1997.Web. 11 March 2015. ‹http://www.fasb.org/ ›.