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Accounting for leases

4.1 Chapter overview

This chapter addresses the initial and subsequent accounting for a lease by a lessor and a lessee,
including impairment and derecognition.

While lease classification does not impact the initial recognition of leases on the balance sheet for a
lessee, how a lease is classified will determine how lease expense is recognized in the income statement
subsequent to initial recognition. For a lessor, the initial and subsequent recognition of a lease
depends on its classification. LG 4.2 and LG 4.3 discuss the initial recognition and measurement for a
lessee and a lessor. LG 4.4 and LG 4.5 discuss the impact of lease classification on the accounting
subsequent to initial recognition. LG 4.6 and LG 4.7 discuss the impairment model to be used by
lessees and lessors. Lease classification is discussed in LG 3.

The modification, remeasurement, and termination of a lease are discussed in LG 5.

4.2 Initial recognition and measurement – lessee

The leases standard requires lessees to record a right-of-use asset and a lease liability for all leases
other than those that, at lease commencement, have a lease term of 12 months or less. A reporting
entity can elect an accounting policy not to record such short-term leases on the balance sheet. See LG
2.2.1 for information on the short-term lease measurement and recognition exemption.

Similar to accounting policies in other areas of GAAP, reporting entities may be able to establish
reasonable capitalization thresholds below which assets and liabilities related to a lease are not
recognized. When establishing an appropriate capitalization threshold, a lessee should evaluate all
relevant quantitative and qualitative factors impacting both the financial statements and the footnote
disclosures, including quantitative information about a lessee’s lease costs. This could result in a lower
capitalization threshold than would be determined based on the financial statement effects alone.

We do not believe it is appropriate for a lessee to net the right-of-use asset and lease liability when
establishing a capitalization threshold. We believe all financial statement line items should be
evaluated individually and in the aggregate when establishing an appropriate threshold.

The following sections discuss the initial recognition and measurement of the right-of-use asset and
lease liability for finance leases and operating leases.

4.2.1 Measuring the lease liability

On the lease commencement date, a lessee is required to measure and record a lease liability equal to
the present value of the remaining lease payments, discounted using the rate implicit in the lease (or if
that rate cannot be readily determined, the lessee’s incremental borrowing rate). Lease payments used
in measuring the lease liability are amounts due to the lessor excluding any payments that a lessee
makes before lease commencement. As discussed in LG 3.3.4, there are six components that should be
factored into measuring lease payments. Lease arrangements should be thoroughly reviewed to ensure
that all applicable payments are being considered.

With some exceptions, the lease payments used to measure the lease liability should be the same as
those used to determine lease classification. Two of these exceptions are:

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