On September 13, 2024, the Accounting Standards Board of Japan (ASBJ), which establishes the Japanese accounting standards, issued the “Accounting Standard for Lease Transactions” (hereinafter referred to as the “New Lease Accounting Standard”). This new lease accounting standard will be effective for fiscal years starting on or after April 1, 2027. This new lease accounting standard mandates accounting rules for “lease transactions” in Japan, which has already been introduced in the International Financial Reporting Standards (IFRS) and U.S.-GAAP.
The new lease accounting standard starts by redefining a lease in order to align it with International Financial Reporting Standards (IFRS 16), making it a standard that might be difficult to understand at first glance.
Here, we would like to provide an overview of the new lease accounting standard without delving too deeply into the definitions (and may lack in accuracy as a result).
Under the current lease accounting standards, only finance leases (Note1) are required to be recorded as assets and liabilities.
The key difference from the current lease accounting standard is that, not only finance leases but also operating leases (Note2) are required to be recorded as assets and liabilities. This is because the determination of whether a contract includes a lease depends on “whether the lessee has the right to control the use of a specified asset.” In other words, if a lessee has the right to use an asset for a specified period of time, even if the period is significantly shorter than the tax depreciation period, it is considered as a lease contract and not a full payout contract (Note 3). Therefore, the lessee is required to recognize the right to use as an asset and the payment obligation should be recognized as a liability. A right-of-use asset is recognized on the asset side and a lease liability is recognized on the liability side. In addition, the amount of lease payments that are expensed in the income statement under the current operating lease accounting standard would be expensed separately as depreciation expense and interest expense.
Moreover, under the current lease accounting standards, “real estate rental transactions” were not considered as lease transactions. However, under the new lease accounting standards, these transactions could potentially be classified as lease transactions. This would increase assets and liabilities, significantly impacting key management indicators such as equity ratio and return on assets (ROA).
In addition, the right-of-use assets from leases will be subject to impairment testing i.e. they will need to be evaluated for potential impairment losses.
Compared to the previous accounting treatment for lease transactions, the number of contracts subject to this new accounting standard is expected to increase significantly, potentially increasing the volume of accounting procedures several-folds. Companies will need to quickly complete their assessments, and prepare for changes s to their business processes and systems to comply with the new standards.
Note 1: A finance lease is a lease arrangement where the total lease payments are almost equivalent to the sum of the purchase price of the asset and the equivalent interest rate, so that the lease can be regarded as effectively the same as purchasing the asset on an installment plan. In some cases, the ownership of the asset may be transferred to the lessee at the end of the lease term (though ownership is not transferred in other cases).
Note 2: An operating lease is a lease arrangement where the asset is returned to the lessor at the end of the lease term. The lease payments are lower than the acquisition price of the asset, thus reducing the total amount of payments.
Note 3: A full-payout lease transaction refers to a lease where the lessee is able to substantially enjoy the economic benefits derived from the leased asset and bears the majority of the costs arising from the use of the leased asset. This includes not only the amount equivalent to the purchase price of the asset but also other expenses such as maintenance costs, which are effectively borne by the lessee.
ASBJ issues Accounting Standard for Leases, etc.｜Accounting Standards Board of Japan (asb-j.jp)
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