Lease Accounting Glossary
Comprehensive definitions for IFRS 16, ASC 842, and FRS 102 lease accounting terminology.
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A
Amortisation (Depreciation of ROU Asset)
The systematic allocation of the cost of a right-of-use asset over the lease term (or useful life, if ownership transfers). Under IFRS 16 and FRS 102, the ROU asset is typically depreciated on a straight-line basis. Under ASC 842, the method depends on whether the lease is classified as a finance lease (front-loaded) or an operating lease (straight-line single expense).
B
Bargain Purchase Option
A purchase option in a lease that allows the lessee to buy the underlying asset at a price significantly below its expected fair value at the date the option becomes exercisable. Under ASC 842, a bargain purchase option that the lessee is reasonably certain to exercise is one of the criteria for classifying a lease as a finance lease.
C
Commencement Date
The date on which a lessor makes an underlying asset available for use by a lessee. This is the date when the lease liability and right-of-use asset are initially recognised, not the date the lease agreement is signed.
Contract Modification
A change to the scope or consideration of a lease that was not part of the original terms. Modifications may be accounted for as a separate lease or as a remeasurement of the existing lease, depending on whether they grant additional right-of-use.
D
Discount Rate
The rate used to calculate the present value of lease payments. This should be the interest rate implicit in the lease if readily determinable; otherwise, the lessee uses its incremental borrowing rate.
Direct Financing Lease
A lessor lease classification under ASC 842 where the present value of lease payments plus the present value of residual asset equals or exceeds substantially all of the fair value of the underlying asset, and there is no selling profit at commencement.
E
Effective Interest Method
A method of calculating the amortised cost of a financial liability (including a lease liability) and of allocating interest expense over the relevant period. Under this method, interest is calculated by applying the discount rate to the carrying amount of the liability, resulting in higher interest expense in early periods that decreases over the lease term as the balance is paid down.
Economic Life
The period over which an asset is expected to be economically usable by one or more users, or the number of production or similar units expected to be obtained from the asset.
Embedded Lease
A lease component contained within a broader service or supply contract. Entities must identify and separate embedded leases from the host contract unless they elect the practical expedient to combine lease and non-lease components.
Extension Option
A contractual option allowing the lessee to extend the lease term beyond the initial non-cancellable period. Extension periods are included in the lease term when it is reasonably certain the lessee will exercise the option.
F
Fair Value
The price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Used in lessor classification tests and sale-and-leaseback transactions.
Finance Lease
A lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset. Under IFRS 16, this classification applies to lessor accounting. Under ASC 842, it is one of two lessee classifications with front-loaded expense recognition.
Fixed Payments
Payments made by a lessee to a lessor for the right to use an underlying asset during the lease term, other than variable lease payments. Includes in-substance fixed payments that may appear variable but are unavoidable in substance.
Full Retrospective Approach
A transition method that applies the new lease standard to each prior reporting period presented, restating comparative financial statements as though the standard had always been in effect. While this provides greater comparability across periods, it is more complex and requires reconstructing historical lease data from commencement date.
G
Guaranteed Residual Value
The portion of the residual value of the underlying asset that is guaranteed by the lessee, a party related to the lessee, or a third party unrelated to the lessor. For lessee accounting, the amounts expected to be payable under a residual value guarantee are included in lease payments used to measure the lease liability.
I
Impairment (ROU Asset)
A reduction in the carrying amount of a right-of-use asset when its recoverable amount falls below its book value. Under IFRS 16, ROU assets are subject to impairment testing under IAS 36. Under ASC 842, impairment is assessed under ASC 360 for long-lived assets. Indicators include planned vacancies, subleasing at a loss, or significant changes in market conditions.
Implicit Rate (Interest Rate Implicit in the Lease)
The rate of interest that causes the present value of (a) the lease payments and (b) the unguaranteed residual value to equal the sum of (i) the fair value of the underlying asset and (ii) any initial direct costs of the lessor.
Incremental Borrowing Rate (IBR)
The rate of interest that a lessee would have to pay to borrow over a similar term, and with a similar security, the funds necessary to obtain an asset of a similar value to the right-of-use asset in a similar economic environment.
Initial Direct Costs
Incremental costs of obtaining a lease that would not have been incurred if the lease had not been obtained. Examples include commissions and legal fees directly related to negotiating and arranging the lease.
Inception Date
The earlier of the date of the lease agreement and the date of commitment by the parties to the principal terms and conditions of the lease. This is distinct from the commencement date, which is when the lessor makes the asset available for use. Lease classification (for lessors) is determined at inception, while measurement occurs at commencement.
In-Substance Fixed Payments
Payments that may appear variable in form but are unavoidable in substance. For example, payments that must be made only if an asset operates or if an event occurs, where occurrence is highly probable or virtually certain.
L
Lease
A contract, or part of a contract, that conveys the right to use an asset (the underlying asset) for a period of time in exchange for consideration. A contract is or contains a lease if it conveys the right to control the use of an identified asset.
Lease Component / Non-Lease Component
A lease component is the right to use an underlying asset within a contract. A non-lease component is any activity or cost that transfers a good or service to the lessee (e.g. maintenance, cleaning, or insurance). Both standards require entities to separate lease and non-lease components, though practical expedients allow combining them. Under ASC 842, lessees may elect to combine by asset class; under IFRS 16, lessees may combine but lessors may not.
Lease Incentives
Payments made by a lessor to a lessee associated with a lease, or the reimbursement or assumption by a lessor of costs of a lessee. Common examples include rent-free periods, tenant improvement allowances, and moving cost reimbursements.
Lease Liability
The obligation to make lease payments, measured at the present value of unpaid lease payments at the commencement date. Subsequently measured using the effective interest method, with the carrying amount increased for interest and decreased for payments made.
Lease Modification
A change in the scope of a lease, or the consideration for a lease, that was not part of the original terms and conditions (e.g., adding the right to use additional assets, extending or terminating the lease, or changing the consideration).
Lease Payments
Payments made by a lessee to a lessor relating to the right to use an underlying asset during the lease term. Includes fixed payments, variable payments based on an index or rate, amounts under residual value guarantees, exercise price of purchase options (if reasonably certain), and termination penalties.
Lease Term
The non-cancellable period of a lease, together with periods covered by an extension option if reasonably certain to be exercised, and periods covered by a termination option if reasonably certain not to be exercised.
Lessee
An entity that obtains the right to use an underlying asset for a period of time in exchange for consideration. The party that makes lease payments and recognises the lease liability and right-of-use asset.
Lessor
An entity that provides the right to use an underlying asset for a period of time in exchange for consideration. Lessors classify leases as either finance leases or operating leases.
Low-Value Asset
An asset that has a low value when new (regardless of age when leased), typically around USD 5,000 or less. IFRS 16 permits an optional exemption to recognise lease payments as expense for low-value asset leases without recognising a lease liability or ROU asset.
M
Modified Retrospective Approach
A transition method that recognises the cumulative effect of initially applying the lease standard as an adjustment to opening equity at the date of initial application, without restating comparative periods. This is the most commonly used transition approach as it avoids the complexity of recalculating historical lease data. Several practical expedients are available to simplify the transition.
N
Net Investment in the Lease
For a lessor in a finance lease, the gross investment in the lease discounted at the interest rate implicit in the lease. Comprises the present value of lease payments receivable plus the present value of any unguaranteed residual value.
Non-Cancellable Period
The period for which the lease is enforceable, including periods covered by termination options held by the lessor, but excluding periods covered by termination options held by the lessee (unless the lessee is reasonably certain not to exercise).
O
Obtainable Borrowing Rate (OBR)
The FRS 102 equivalent of the incremental borrowing rate (IBR) used under IFRS 16. It is the rate at which the lessee could borrow over a similar term, with similar security, the funds necessary to obtain an asset of similar value in a similar economic environment. The terminology differs but the underlying concept and calculation approach are the same.
Operating Lease
A lease that does not transfer substantially all the risks and rewards incidental to ownership. Under IFRS 16 and ASC 842, this classification applies to lessor accounting and (for ASC 842) to lessee accounting with straight-line expense recognition.
P
Portfolio Approach
A practical expedient allowing entities to apply IFRS 16 or ASC 842 to a portfolio of leases with similar characteristics if the entity reasonably expects that the effects would not differ materially from applying the standard to individual leases.
Practical Expedient
A simplification permitted by the standard that allows entities to reduce the cost or complexity of applying certain requirements. Common examples include the short-term lease exemption, low-value asset exemption, combining lease and non-lease components, using a portfolio approach, and various transition reliefs such as grandfathering prior lease assessments.
Present Value
The current worth of future cash flows, discounted at an appropriate interest rate. Used to measure lease liabilities at the commencement date by discounting future lease payments at the discount rate.
Purchase Option
A contractual option giving the lessee the right to purchase the underlying asset at the end of the lease term. If reasonably certain to be exercised, the exercise price is included in lease payments and the asset is depreciated over its useful life rather than the lease term.
R
Reasonably Certain
A high threshold of probability used to assess whether lease options will be exercised. Factors include economic incentives, entity-specific factors, and past practice. Higher than "more likely than not" but not as high as "virtually certain."
Reassessment
The process of re-evaluating the lease term or whether a purchase option is reasonably certain to be exercised when there is a significant event or change in circumstances within the lessee's control.
Remeasurement
Recalculating the lease liability when there is a change in lease term, exercise of purchase option, or change in amounts expected to be payable under residual value guarantees or variable payments based on an index or rate.
Restoration Costs (Dilapidation Provision)
Estimated costs a lessee expects to incur to restore the leased asset to the condition required by the lease (e.g. removing leasehold improvements or making good on a property at lease end). These costs are included in the initial measurement of the right-of-use asset and recognised as a provision under IAS 37 or ASC 410.
Residual Value Guarantee
A guarantee made to a lessor that the value of an underlying asset at the end of a lease will be at least a specified amount. Amounts expected to be payable under residual value guarantees are included in lease payments.
Right-of-Use Asset (ROU Asset)
An asset that represents a lessee's right to use an underlying asset for the lease term. Initially measured at cost (comprising the lease liability, prepayments, initial direct costs, and restoration costs), then depreciated over the shorter of the useful life or lease term.
S
Sale and Leaseback
A transaction in which an entity (seller-lessee) sells an asset to another entity (buyer-lessor) and immediately leases the same asset back. If the transfer qualifies as a sale under IFRS 15/ASC 606, specific accounting applies to measure the ROU asset and any gain or loss.
Sales-Type Lease
A lessor lease classification under ASC 842 where one of the finance lease criteria is met. The lessor recognises selling profit or loss at commencement and subsequently recognises interest income over the lease term.
Short-Term Lease
A lease that, at commencement, has a lease term of 12 months or less and does not contain a purchase option that the lessee is reasonably certain to exercise. Both standards permit an elective exemption to recognise payments as expense without capitalising.
Sublease
A transaction in which an underlying asset is re-leased by a lessee (intermediate lessor) to a third party, with the original lease (head lease) remaining in effect. The intermediate lessor accounts for the sublease as a lessor while maintaining lessee accounting for the head lease.
T
Termination Option
A contractual option allowing either party to terminate the lease before the end of the non-cancellable lease term. When held by the lessee, periods after the termination option are excluded from the lease term unless reasonably certain not to exercise.
Transition
The process of first-time adoption of the lease accounting standard. Both standards offer practical expedients including the modified retrospective approach (no restatement of comparatives) and the ability to grandfather certain assessments from the prior standard.
U
Underlying Asset
An asset that is the subject of a lease, for which the right to use has been conveyed to a lessee. Common examples include real estate, vehicles, equipment, and machinery.
Unguaranteed Residual Value
The portion of the residual value of the underlying asset at the end of the lease term, the realization of which by the lessor is not assured or is guaranteed solely by a party related to the lessor. Relevant for lessor accounting and determining the implicit rate.
Useful Life
The period over which an asset is expected to be available for use by an entity, or the number of production or similar units expected to be obtained from the asset. Used to determine ROU asset depreciation when the lease transfers ownership or contains a purchase option reasonably certain to be exercised.
V
Variable Lease Payments
The portion of payments made by a lessee to a lessor that varies because of changes in facts or circumstances occurring after the commencement date. Those linked to an index or rate are included in the lease liability; those linked to usage or performance are expensed as incurred.
W
Weighted Average Remaining Lease Term
A disclosure metric that calculates the average remaining lease term across a portfolio, weighted by the lease liability or right-of-use asset balance of each lease. Commonly disclosed alongside the weighted average discount rate to give stakeholders insight into the overall maturity profile and cost of the lease portfolio.
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