What will be an ideal response?
Answer: The most pronounced difference between accounting for leases under GAAP and IFRS is the absence of bright line tests in IFRS. IFRS is more principles-based than rules based and requires that more judgment be exercised. Whereas, GAAP uses the 75% of economic life test and/or the 90% test for the present value of minimum line payments to determine whether a lease is a capital lease or an operating lease, IFRS identifies five situations that individually or in combination could lead a lease to be classified as a finance lease, which is the IFRS equivalent of a capital lease:
1. The lease transfers ownership of the property to the lessee at the end of the lease term. This is similar to GAAP.
2. The lease contains a bargain purchase option allowing the lessee to acquire property at a price specified at the inception of the lease that is substantially below the expected fair market value of the property at the date the option can be exercised. again, this is similar to GAAP.
3. The lease term is for the major part of the economic life of the asset even if title is transferred. This is similar to the 75% test.
4. The present value of the minimum lease payments amounts to substantially all of the leased asset’s fair value. This is similar to the 90% test.
5. The leased asset is of such a specialized nature that only the lessee can use it without modifications. This is unique to IFRS.
IFRS also has three additional criteria that imply a finance lease exists:
1. The lessee bears the lessor’s losses if the lessee cancels the lease.
2. The lessee absorbs the gains or losses from fluctuations in the fair value of the residual value of an asset.
3. The lessee may extend the lease for a secondary period at a rent substantially below the market rate in a bargain renewal option.