For many reporting entities, leasing is an important way to obtain access to property. It allows lessees to finance the use of necessary assets, often simplifies the disposal of used property, and reduces a lessee’s exposure to the risks inherent in asset ownership.

Leasing guidance (before the issuance of ASU 2016-02) required lessees to classify leases as either capital or operating leases.. Lessees recognized assets and obligations related to capital leases; expenses associated with capital leases were recognized by amortizing the leased asset and recognizing interest expense on the lease obligation. Many lease arrangements were classified as operating leases, under which lessees would not recognize lease assets or liabilities on their balance sheet, but rather would recognize lease payments as expense on a straight line basis over the lease term. The leasing guidance was often criticized for not providing users the information necessary to understand a reporting entity’s leasing activities, primarily because it did not provide users with a comprehensive understanding of the costs of property essential to a reporting entity’s operations and how those costs were funded. Users frequently analyzed information from a reporting entity’s lease-related disclosures to compare that reporting entity’s performance with other companies. The user community and regulators frequently called for changes to the accounting requirements that would require lessees to recognize assets and liabilities associated with leases. In 2008, the FASB and IASB (collectively, the “boards”) initiated a joint project to develop a new standard to account for leases. Although many of the perceived problems with the previous leasing guidance related to a lessee’s accounting for operating leases, the boards thought it beneficial to reflect on lease accounting holistically, and to consider lessor accounting while concurrently developing a proposal on revenue recognition (ASC 606, Revenue from Contracts with Customers, which was issued in May 2014). The FASB issued ASU 2016-02 (the “leasing standard” or “ASC 842”) in February 2016. Although the project began as a joint project, the boards diverged in some key areas. Most significantly, the boards did not agree on whether all leases should be accounted for using the same model. After significant deliberation, the IASB decided that lessees should apply a single model to all leases, which is reflected in IFRS 16, Leases, released in January 2016. The FASB decided that lessees should apply a dual model. Under the FASB model, lessees will classify a lease as either a finance lease or an operating lease, while a lessor will classify a lease as either a sales-type, direct financing, or operating lease. Under the FASB model, a lessee should classify a lease based on whether the arrangement is effectively a purchase of the underlying asset. Leases that transfer control of the underlying asset to a lessee are classified as finance leases (and as a sales-type lease for the lessor); lessees will classify all other leases as operating leases. In an operating lease, a lessee obtains control of only the use the underlying asset, but not the underlying asset itself.

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