Short-term leases are leases which do not contain any purchase option and which have a lease term of 12 months or less at the commencement date.
The new lease accounting standards, IFRS 16 and its ASC 842, its US GAAP equivalent, require lessees to bring most of their leases on balance sheet by recognizing a right of use asset and a lease liability. There are two exceptions to this capitalization requirement, namely short-term leases, and leases of low-value items.
Lessees can elect by a class of underlying assets not to recognize short-term leases on balance sheet. It means that this choice cannot be made on individual lease basis but must be applied to all leases belonging to a particular class.
For a lease to qualify as a short-term lease, it must meet the following requirements:
- The lease term at the commencement date must be 12 months or less; and
- The lease must not contain a purchase option.
Accounting for short-term leases
As the short-term leases are not capitalized, there is no recognition of depreciation expense on the right of use asset and finance cost on lease liability.
The lessee recognizes payments on short-term leases as an expense either on the straight-line or some other systematic basis. This treatment is just like the treatment for an operating lease under IAS 17, the previous lease accounting standard under IFRS.
Modification and extension of short-term lease
If a short-term lease is extended using an option which was not considered at the commencement date, the lease may still qualify for short-term lease if the following condition is met:
- US GAAP: The remaining lease term at the expiry of the original term is 12 months or less.
- IFRS: The remaining lease term at the date of notice of extension is 12 month or less.