Theory and Practice
When lease payments are denominated in a currency different from the lessee’s functional currency, currency movements can affect the value of the lease obligation and the cost of the lease in the financial statements.
IFRS
A lease liability is a monetary liability. Under IAS 21 (Effects of Changes in Foreign Exchange Rates), monetary items are retranslated at each reporting date using the closing exchange rate, with differences recognized in profit or loss (IASB, 2004b). The ROU asset is a non-monetary asset measured at historical cost (i.e., translated at the exchange rate on the lease commencement date and not subsequently retranslated) (IASB, 2004b). This means that foreign exchange gains and losses arise on the lease liability, not on the asset. For example, consider a 10-year property lease with fixed annual payments of $100,000, and assume the lessee’s functional currency is EUR. The lessee’s initial entries in EUR for the ROU asset and lease liability are based on the exchange rate at commencement (say 0.90 EUR/USD). If by year-end the rate changes (say to 0.95), the remaining lease liability (a USD-denominated obligation) is revalued using the new rate, resulting in an FX loss (because it now takes more euros to settle the same USD liability). The ROU asset remains at the original exchange rate (minus depreciation). Thus, exchange differences on the lease liability hit the Income Statement each period (as part of finance cost or foreign exchange gains/losses), while the ROU asset’s carrying amount is not updated for currency changes (IASB, 2004b). This is consistent with standard IAS 21 treatment of monetary vs non-monetary items.
US GAAP
ASC 830 (Foreign Currency Matters) has similar principles. A foreign-currency lease liability is a monetary liability, remeasured at each period-end using the current exchange rate, with differences going to income (Financial Accounting Standards Board, 2016b). The ROU asset is non-monetary and stays at the historical rate (with no ongoing remeasurement). The outcome is the same as IFRS: whenever exchange rates move, the company will record an FX gain or loss reflecting the change in the value of the lease obligation in its accounts, whereas the asset side (and depreciation) is unaffected by currency movements. Practical insight: Neither IFRS nor GAAP permit deferring these translation gains/losses (unlike certain cases for net investment in foreign operations, which is a different scenario). Thus, lessees with substantial foreign-currency leases should expect Income Statement volatility due to currency fluctuations and might consider hedging the currency risk. The lease liability’s remeasurement due to FX does not impact the ROU asset, so there can be a mismatch between the asset and liability values over time. This is normal and expected under both standards (Financial Accounting Standards Board, 2016b).
UK GAAP
Section 30 of FRS 102 follows the same approach as IAS 21. Therefore, under UK GAAP a foreign currency lease liability is treated as a monetary item (retranslated through profit or loss each period-end) and the ROU asset is non-monetary (recorded at the historical rate and not retranslated) (FRC, 2018). This again aligns FRS 102 with IFRS and US GAAP on foreign currency effects.