Skip to main content

Why do lease accounting standards converge—yet still differ?

In 2016, the IASB adopted IFRS 16, a revolutionary overhaul of lease accounting that brought nearly all leases onto the balance sheet. In 2018, the FASB adopted ASC 842, its close cousin, which did nearly the same thing. For decades, leases had been a form of hidden debt; companies structured them as "operating leases" to keep them off the balance sheet and boost reported profitability. IFRS 16 and ASC 842 largely ended that game. Both standards require recognition of a right-of-use (ROU) asset and a lease liability for nearly all leases.

Yet they are not identical. Differences remain in classification, measurement, subsequent accounting, and transition rules. A company can adopt IFRS 16 and record different lease assets and liabilities than it would have under ASC 842. For investors comparing a US GAAP company to an IFRS competitor, these nuances matter, especially for lease-heavy industries like airlines, retail, and real estate.

This article walks through the convergence, the key differences, and the pitfalls for cross-border comparison.

Quick definition​

IFRS 16 and ASC 842 are lease accounting standards that require recognition of a right-of-use asset and lease liability on the balance sheet for most leases. IFRS 16 (effective 1 January 2019) uses a single classification model; ASC 842 (effective 15 December 2018) retains a two-class model (operating vs finance leases). Both measure the ROU asset and liability similarly, but differences exist in subsequent remeasurement, sale-and-leaseback treatment, and low-value asset exemptions.

Key takeaways​

  1. Both standards bring leases onto the balance sheet — The days of keeping operating leases entirely off-balance-sheet are over. Both IFRS 16 and ASC 842 require recognition of an ROU asset and lease liability for leases ≥12 months.

  2. IFRS 16 uses a single model; ASC 842 retains two classes — IFRS 16 recognises all leases; operating vs finance distinction is gone. ASC 842 distinguishes operating leases (ROU asset and liability) from finance leases (similar to capital leases under old rules). The distinction matters for P&L presentation.

  3. Operating expense vs depreciation: a presentation gap — Under IFRS 16, lease expense is split into depreciation of the ROU asset and interest on the lease liability (like a loan). Under ASC 842 for operating leases, a single "lease expense" is recognised, smoothing the P&L. For finance leases, ASC 842 mimics IFRS 16. This creates comparability issues.

  4. Low-value and short-term exemptions differ — IFRS 16 exempts short-term leases (≤12 months) and low-value assets (typically <$5,000). ASC 842 has similar exemptions but different thresholds and conditions. A lease exempt under one standard may be recognised under the other.

  5. Variable lease payments and reassessment differ — IFRS 16 includes more variable payments in the lease liability and reassesses more frequently. ASC 842 is narrower on variable inclusion and reassessment. This affects both the magnitude of ROU assets and future liability changes.

  6. Lease classification affects financial metrics — Under ASC 842, operating lease expense is a single P&L line, which can make operating metrics (operating income, EBITDA) look better than under IFRS 16, where the expense is split into depreciation and interest.

The pre-2016/2018 world and why it needed fixing​

Before IFRS 16 (2019) and ASC 842 (2019), operating leases were an accounting loophole. A company could lease a factory, a fleet of trucks, or a retail store and record a simple rent expense in the P&L without showing the corresponding asset and liability on the balance sheet. This was called "off-balance-sheet financing." From an investor perspective, the company's balance sheet looked less leveraged than it truly was.

The accounting rationale was that operating leases were "short-term" rentals with no ownership substance. But in practice, many operating leases were de facto long-term financing arrangements. An airline leasing planes for 15-year terms, or a retailer with multi-decade store leases, was financing assets in substance, but the balance sheet showed neither the asset nor the debt.

This distorted financial metrics. A heavily-leased company (like an airline or retail chain) could report lower total debt, lower total assets, and higher operating margins than a company that owned equivalent assets outright. Cross-industry comparison was nearly impossible.

IFRS 16 (adopted first by the IASB) and ASC 842 (adopted by the FASB) fixed this by bringing nearly all leases onto the balance sheet. The scope is vast: any contractual arrangement that gives a lessee the right to use an asset for a period in exchange for consideration is a lease. This includes car rentals, office spaces, cloud services with dedicated infrastructure, and equipment rentals.

The convergence: ROU asset and lease liability​

Both IFRS 16 and ASC 842 require the lessee to recognise:

  1. A right-of-use (ROU) asset — representing the lessee's right to use the leased asset over the lease term.
  2. A lease liability — the obligation to pay lease payments.

Both are measured similarly at lease commencement:

  • Lease liability = present value of all lease payments (fixed and, in some cases, variable) discounted at the lessee's incremental borrowing rate (the rate the lessee would pay to borrow for a similar term and credit profile).
  • ROU asset = lease liability + direct lease costs (e.g., legal fees) + initial direct costs, minus any lease incentives received.

The ROU asset is then depreciated (straight-line) over the lease term. The lease liability is accreted using the interest method; interest expense is recognised in the P&L, and principal is reduced as payments are made.

Example:

  • A company leases a building for 10 years at $1 million per year (fixed). The incremental borrowing rate is 5%.
  • Lease liability at commencement: $7.7 million (PV of $1 million × 10 years at 5%).
  • ROU asset at commencement: $7.7 million (assuming no direct costs or incentives).
  • Year 1: Interest expense on the liability is $385,000 (5% × $7.7 million). The company pays $1 million in cash. The liability decreases to $6.935 million ($7.7 million + $385,000 interest – $1 million payment).
  • Year 1: Depreciation of the ROU asset is $770,000 ($7.7 million / 10 years). Total P&L impact is interest ($385,000) + depreciation ($770,000) = $1.155 million.
  • Cash outflow is $1 million (the lease payment). The $155,000 difference is non-cash (the depreciation and interest are accounting allocations).

Both standards follow this model. The differences lie in classification, measurement refinements, and subsequent accounting.

The key difference: classification under ASC 842​

ASC 842 retains a two-class distinction: operating leases and finance leases. Classification is based on bright-line tests:

  1. Finance lease if:

    • The lease transfers ownership by the end of the term, OR
    • The lease grants an option to purchase at a bargain price, OR
    • The lease term is ≥75% of the asset's useful economic life, OR
    • The present value of lease payments is ≥90% of the asset's fair value, OR
    • The asset is so specialised that only the lessee can use it.

  2. Operating lease if: none of the above criteria are met.

For finance leases, the P&L presentation is identical to IFRS 16: depreciation of the ROU asset and interest expense on the liability.

For operating leases, ASC 842 allows a simplified presentation: a single "operating lease expense" line item, typically equal to the straight-line rent payment. This is a smoothing mechanism; the cash rent may vary, but the accounting expense is constant.

This is a material presentation difference. An airline using ASC 842 can show a single aircraft-lease expense line, which appears as an operating expense, not split into depreciation and interest. Under IFRS 16, the same lease is split, with depreciation hitting the operating section and interest hitting the non-operating section. Operating margins and operating income are calculated differently.

IFRS 16, by contrast, uses a single model for all leases. There is no operating vs finance distinction. All leases are treated the same; ROU asset depreciation and lease liability interest are both recognised, and the split is mandatory.

Measurement differences​

Incremental borrowing rate: Both standards use it. However, ASC 842 requires the lessee to determine the rate it would pay to borrow for a similar tenor and credit profile. IFRS 16 allows the same, but some jurisdictions (particularly where the lessee's rate is difficult to determine) interpret IFRS 16 as permitting reference to the lessor's implicit rate if readily determinable. This can create measurement differences.

Low-value asset exemption: IFRS 16 exempts leases of low-value assets (broadly, assets worth <$5,000 new). ASC 842 also has a low-value exemption, but the treatment is narrower. IFRS 16 exempts the entire lease; ASC 842 may still require an ROU asset and liability, just with different measurement. This is a source of divergence for portfolios of small, low-value leases.

Short-term lease exemption: Both standards exempt leases with ≤12 months of remaining term at lease commencement (or reassessment). However, IFRS 16 permits a portfolio approach (grouping similar short-term leases), while ASC 842 is more prescriptive about when the exemption applies. Again, minor but material for high-volume, short-term lessees.

Variable lease payments: IFRS 16 includes more variable payments in the lease liability (e.g., rent escalations tied to indices, usage-based charges). ASC 842 is narrower, excluding some variable payments. This affects both the initial ROU asset/liability and future remeasurement.

Operating-lease expense presentation: the P&L impact​

This is the biggest practical difference for investors using metrics like operating income, operating margin, and EBITDA.

IFRS 16 (all leases):

  • Depreciation of ROU asset: classified as operating expense.
  • Interest on lease liability: classified as non-operating (interest expense).
  • Operating income = revenues – operating expenses (including depreciation).
  • EBITDA typically adds back depreciation, so EBITDA appears to include lease payments (since depreciation is reversed).

ASC 842 (operating leases only):

  • Single operating lease expense (rent): classified as operating expense.
  • Operating income = revenues – operating expenses (including operating lease expense).
  • For EBITDA purposes, the treatment varies. Some companies add back the total operating lease expense; others add back only depreciation, creating discrepancies.

Practical impact: Two similar airlines with similar assets and lease terms will report different operating income under IFRS 16 versus ASC 842. The IFRS 16 airline splits the expense into depreciation (operating) and interest (non-operating), making operating income lower. The ASC 842 airline reports a single operating lease expense, which may make operating income and operating margin appear better (since interest is not a separate, non-operating deduction).

For cross-border comparison, an investor must recompute operating income consistently, either:

  • Splitting the ASC 842 operating lease expense into depreciation and interest (to match IFRS 16), or
  • Combining IFRS 16 depreciation and interest into a single lease expense (to match ASC 842).

Real-world examples​

American Airlines vs Lufthansa: American Airlines (US GAAP, ASC 842) reports operating lease expense as a single line. Lufthansa (IFRS 16) splits lease expense into depreciation and interest. Both companies have vast aircraft leases, but their operating margins appear different due to the presentation. Restating American to match Lufthansa's treatment shows that the margin gap narrows; the difference was largely accounting, not operational.

Amazon (Whole Foods stores) vs Carrefour: Amazon's Whole Foods stores are leased (primarily operating leases under ASC 842). Carrefour (IFRS 16) leases most of its retail space. On a headline basis, Carrefour's operating margin appears lower due to the interest-expense split. Adjusting both to a consistent presentation reveals comparable store profitability.

Container shipping lines: Companies like Maersk (IFRS) and Hapag-Lloyd (IFRS) versus A.P. Moller-Maersk (IFRS) all use IFRS 16, so their presentations are consistent. However, if comparing to a smaller US shipper (ASC 842), the operating vs non-operating split for leases will differ.

Common mistakes​

  1. Assuming IFRS 16 and ASC 842 are identical — They converged significantly, but differences remain in classification, presentation, and measurement. A company cannot simply adopt one standard expecting to produce the same results as under the other.

  2. Using operating income or operating margin without adjusting for lease-payment timing differences — The depreciation/interest split differs, but so can the total lease expense due to variable-payment inclusions and reassessment policies. Always verify that the lease-expense components are comparable.

  3. Ignoring the low-value and short-term exemptions — A company with a high volume of short-term or low-value leases will record fewer ROU assets and liabilities under IFRS 16 (broader exemption) than ASC 842 (narrower exemption). Portfolio effects can be material.

  4. Forgetting that ASC 842 allows a simplified operating-lease presentation — An investor comparing an ASC 842 operating lease (single expense) to an IFRS 16 lease (depreciation + interest) may think the IFRS 16 company has higher operating expense, when in fact the total P&L impact is the same, just presented differently.

  5. Assuming lease liabilities are debt — Lease liabilities are debt-like (they are obligations to pay), but some debt ratios exclude them, and lenders may treat them differently than traditional debt. Always clarify whether a given ratio includes or excludes lease liabilities.

FAQ​

Q: Are there still off-balance-sheet leases under IFRS 16 or ASC 842? A: Rarely. Both standards have a very broad scope. However, low-value asset and short-term lease exemptions can exempt some leases. Additionally, arrangements that are not legally classified as leases (e.g., service contracts with usage components) may escape lease accounting. But the days of widespread off-balance-sheet lease financing are over.

Q: How do I calculate the incremental borrowing rate if it's not disclosed? A: Both standards permit reasonable estimation. Typical approaches include: (a) the lessee's existing borrowing rate on other debt, (b) the rate on a hypothetical loan for a similar tenor and credit profile, (c) the lessor's implicit rate if readily available. Companies disclose the rate used in the footnote; if not, you may need to infer it from the disclosed ROU assets and liabilities.

Q: If a company transitions from ASC 842 to IFRS 16, will its financial statements change? A: Yes, potentially. The ROU asset and liability may differ due to measurement-method differences (incremental borrowing rate, variable-payment inclusion, low-value exemptions). Additionally, the P&L presentation will change; operating lease expense (single line under ASC 842) will split into depreciation and interest under IFRS 16, affecting operating margins.

Q: Do lease accounting standards apply to lessors as well as lessees? A: Yes, but this article focuses on lessee accounting, which is the dominant investor concern. Lessor accounting is more complex and less affected by IFRS 16 versus ASC 842 differences. However, some lessor entities (e.g., captive auto-financing arms) report significant impacts.

Q: If I see a very high lease liability relative to the ROU asset, what does it mean? A: It could indicate (a) that the lease has deferred payments (higher payments in later years), (b) that initial direct costs were low, or (c) that initial incentives were high. The mismatch between ROU asset and lease liability should be explained in the footnote; if not clearly stated, ask management.

Q: How do I adjust EBITDA for leases across IFRS 16 and ASC 842? A: The simplest approach is to add back the operating lease expense (the cash rent) to operating income, yielding a "lease-adjusted EBITDA" that is consistent across both standards. Alternatively, build an adjusted operating income by removing depreciation and interest on leases, then add back the total lease payment. Either way, you are removing the accounting split and focusing on the cash impact.

  • Right-of-use assets and lease liabilities — Understand how these are measured at inception and remeasured when lease terms change.
  • Lease payment calculations and present value — Understanding the discount rate and payment streams is fundamental to lease accounting.
  • Operating vs non-operating expense classification — Lease expenses are split differently under IFRS 16 and ASC 842; understand which sections of the P&L they affect.
  • EBITDA and adjusted metrics — Lease expenses must be carefully handled when calculating EBITDA or other adjusted metrics; consistency across regimes is essential.
  • Segment reporting and leases — Lease expense may be allocated to segments; understand how this affects segment profitability comparisons.

Summary​

IFRS 16 and ASC 842 represent a major convergence in lease accounting, bringing nearly all leases onto the balance sheet as ROU assets and lease liabilities. For investors, the most important change is that leases are no longer hidden; balance-sheet leverage is now visible. However, differences between the standards remain, particularly in P&L presentation (IFRS 16 splits depreciation and interest; ASC 842 allows a single operating lease expense for operating leases), measurement of low-value and short-term exemptions, and variable-payment inclusion.

The key for cross-border comparison is to restate both standards to a common presentation, typically by converting ASC 842's operating lease expense into depreciation and interest components (to match IFRS 16), or vice versa. Operating margins and EBITDA should be adjusted to ensure consistency.

Lease-heavy industries (airlines, retail, real estate) are most affected by these standards. Investors in these sectors must carefully review lease footnotes, understand the incremental borrowing rates and payment terms, and adjust financial metrics accordingly. The convergence has improved transparency, but the remaining differences require active reconciliation to ensure fair comparison.

Next​

Financial instruments: ASC 326 (CECL) vs IFRS 9