Does a change to accounting for leases under US GAAP impact my UK entity

05 August 2021

ASC 842 Leases is a new US GAAP standard and the good news is it’s similar to IFRS 16. The bad news is that for the FRS 102 reporters in the UK, you will have a GAAP difference for internal group reporting. This can be managed, to some degree, by adopting FRS 101 or IFRS.

The ASC has allowed private US GAAP reporters the opportunity to delay their application of ASC 842 Leases until their accounting periods beginning on or after 15 December 2021, if they have not already adopted the new standard.

Understanding the impact of a new standard to an entity applying a different accounting framework to its financial statements isn’t always an immediate consideration, particularly if that entity is a subsidiary, but it does need to be well-thought-out, and the sooner the better.

It’s important to bear in mind that this can be an extensive exercise and, in some cases, may require significantly more time and effort than the IFRS 15 / ASC 606 transitions.

Does this affect me?

If you are a UK subsidiary of a US parent or a UK parent with a US subsidiary, the application of ASC 842 Leases creates a GAAP difference in the recognition and accounting of leases with FRS 102 Section 20 and IFRS 16 that needs to be explored for your group financial reporting.

What are these GAAP differences?

ASC 842 brings all leases, subject to practical expedients available, onto the balance sheet, much like IFRS 16, with the recognition of a lease liability and right-of-use asset but maintains a greater distinction between operating and finance leases.

For a lessee, ASC 842 sets out five criteria, set out below, which if any are met at lease commencement give rise to a finance lease. All other leases of the lessee are classified as operating leases.

  1. The lease transfers ownership of the underlying asset to the lessee by the end of the lease term;
  2. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise;
  3. The lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for purposes of classifying the lease;
  4. The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not yet reflected in the lease payments in accordance with paragraph 842-10-30-5(f) equals or exceeds substantially all of the fair value of the underlying asset;
  5. The underlying asset is of such a specialised nature that it is expected to have no alternative use to the lessor at the end of the lease term.

Income statement

The table below shows how the operating leases are presented in the income statement.

Operating leases only ASC 842 FRS 102 IFRS 16
Total expense in income statement Annual charge based on length of the lease Annual charge based on length of the lease Total depreciation and interest charged
Finance costs Annual unwind of lease liability using appropriate discount rate N/A - no liability recognised on the balance sheet Annual unwind of lease liability using appropriate discount rate
Depreciation Balance of the total expense to be recognised less the finance costs N/A – no asset recognised on the balance sheet Annual charge of the cost of the asset over the term of the lease
Impact on EBITDA No cost is included The total cost of the lease is included No cost is included

Finance leases

Finance leases are recognised consistently across US GAAP, IFRS, and UK GAAP. The assets and liabilities relating to such leases are recognised on the balance sheet and depreciation and interest being charged to the profit or loss.

Balance sheet

ASC 842 and IFRS 16 both recognise an asset and liability for all leases whereas FRS 102 only recognises an asset and liability for finance leases. In respect of the operating leases, depreciation charged on the right-of-use asset under ASC 842 will be lower at the start of the lease compared to the depreciation charged under IFRS 16. This means that the carrying value of the asset, and by extension total assets, will be greater than under IFRS 16. In turn this also impacts your net assets, an important point to note for your KPIs on internal reporting and when reporting for bank covenants.

Discount rate

ASC 842 and IFRS 16 both use a discount rate to unwind the lease liabilities used but these rates are not defined the same and differences may arise. A discount rate is not required under FRS 102 and therefore will need to be determined when applying ASC 842 to UK lease arrangements.

Practical expedients

These are ways the standards offer with the aim to make their practical application easier. ASC 842 and IFRS 16 both offer practical expedients, but they are not consistent, whereas FRS 102 does not offer any practical expedients at all. For example, the practical expedient for the treatment of modifications due to COVID-19 each operate slightly differently for each of the GAAPs.

Will lease accounting change under FRS 102?

The Financial Reporting Council (FRC) has recently launched its next mandatory review of FRS 102 aimed at improving and clarifying this financial reporting standard.

It is expected that the accounting for leases under FRS 102 will change but how this will look and when it will change is not yet known. Our financial reporting team will continue to monitor developments and respond as appropriate to future consultations.

‘What next for FRS 102?’ features further information about the potential changes and how you can prepare.

What do I need to do?

The above highlights some of the differences between US GAAP and UK GAAP / IFRS when accounting for leases but not in its totality, therefore a full review will be needed.

Those FRS 102 reporters may wish to consider if FRS 102 is still the right reporting framework for you or whether FRS 101 / IFRS fits your needs better. Look out for our next article that focuses on your options.

How RSM can help

Whether you require a GAAP assessment in respect of leases only or are considering a change to your reporting framework, RSM can help.

RSM has a national team of accounting and financial reporting experts across the UK. We can help with everything from a friendly chat to more formal review and assessments of differences or full implementations.

For further information please contact Nicola Whitmarsh, or your usual RSM contact.