A ccounting Treatment of Lease is the most important part of capital structure management. Financial leases were “of the balance sheet” financing. That is lease obligations often were not recorded on the balance sheet, but listed in footnotes, instead. Not explicitly accounting of leases frequently resulted in a failure to state operational assets and liabilities fairly.
In 1997 the Financial Accounting Standards Board (FASB), the rule-making body of the accounting profession, required that capital leases be recorded on the balance sheet as both an asset and a liability. This was in acknowledgment of the long-term nature of a lease commitment.
In an operating lease, the lessor (or owner) transfers only the right to use the property to the lesses. Toward the finish of the lease period, the lessee restores the property to the lessor. Since the lessee does not expect the risk of ownership, the lessee cost is treated as an operating expense in the pay an announcement and the lease does not influence the balance sheet report.
In a Capital Lease, the Lessee accepts a portion of the risk of proprietorship and appreciates a portion of the advantages. Consequently, the lease, when signed, is recognized both as an asset and a liability (for the lease payment) on the balance sheet. The firm gets to claim depreciation each year on the asset and also deducts the interest expenses component of the lease payment each year. When all is said in done, capital leases perceive costs sooner than identical operating leases.
Since firms prefer to keep leases off the books, and sometimes prefer to defer expenses, there is a strong incentive on the part of firms to report all leases as operating leases.
- In the event that the lease life surpasses 75% of the life of the asset.
- On the off chance that there is an exchange of ownership to the lessee toward the finish of the lease term.
- On the off chance that there is a choice to buy the asset at a “Deal Price” toward the finish of the lease term.
- If the percent value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of the fair market value of the asset.
The lessor utilizes similar criteria for deciding if the lease is a capital or working lease and records for it appropriately. If it is a capital lease, the lessor records the present value of the future cash flows as revenue and recognizes expenses. The lease receivable is also shown as an asset on the balance sheet, and the interest revenue is recognized over the term of the lease, as paid. Structure of tax standpoint, the lessor can guarantee the tax cuts of the leased resource just on the off chance that it is an operating lease, however, the income code utilizes somewhat various criteria for deciding if the lease is an operating lease.
When a lease is classified as an operating lease, the lease expenses are treated as operating expenses and the operating lease does not show up as part of the capital of the firm. At the point when a lease has delegated a capital lease, the present estimated value of the lease costs is treated as Debt, and interest is credited on this sum and appeared as a major aspect of the income statement. In useful terms, be that as it may, renaming operating lease as capital leases can expand the Debt appeared on the accounting report considerably particularly for firms in areas which have critical operating leases; airlines and retailing come to mind.
We would make the argument that in an operating lease, the lease installments are the same amount of responsibility as lease expenses in a capital lease or interest installments on Debt. The way that the lessee may not take responsibility for resource toward the finish of the lease time frame, which is by all accounts the core on which the operating lease decision is made, ought not to be a critical factor in whether the duties are treated as what could be compared to Debt.
Accounting Treatment for Operating Leases
The accounting treatment for an operating lease is straightforward for both lessor and the lessee. The lessee has incurred operating expenses, so the lease rental payable is written-off in the profit and loss account. The lessee needs to uncover in the notes to the records the amount charged in the year and the measure of the installments to which the element is submitted at the year-end.
The lessor has earned revenue for renting out the asset and accordingly recognizes the lease rental receivable as income in the profit and loss account.
Accounting Treatment of Finance Leases-by the Lessee
“A Liability is defined as an obligation to transfer economic benefits as a result of a past transaction or events”
At the point when a lessee goes into a budgetary rent, it is gaining admittance to the risks and prizes of the benefit and in like manner, the lessee reflects substance by perceiving the advantage in its very own records. This is consistent with the ASB’s statement of principles definition of and recognition criteria of an asset.
The lessee strictly capitalizes the present value of the minimum payments as the fixed asset and this is the amount also recorded as the liability. The present value of the minimum lease payment normally equates to the cash price. The benefit must be devalued over the shorter of the time of the rent and the helpful existence of the advantage. The loan accrues interest, which should be recognized to give a constant periodic return on the balance of the outstanding loan. The rental payment is not therefore simply a revenue expenses but represents partly the repayment of the capital element of the loan and partly the finance charge on the loan. The complete money charge is the contrast between the base rent installments and the present estimation of the base rent installments.
Accounting Treatment of Finance Leases-by the Leasor
Lessors are ordinarily banks or comparable loaning organizations. When going into a money rent the lessor is in substance making a credit which will be reimbursed with premium. Despite having legal title to the resources subject to the rent, the lessor does not perceive this as an advantage on its accounting report, as it doesn’t control the advantage and does not approach the future monetary advantages. The lessor does, however, have the asset of a future income and accordingly recognizes a debtor “Net Investment in fiance Leases”.
A lease is a contract whereby one party grants other parts exclusive right to make the use of asset of an agreed period of time in return for the payment of rent. The most common types of lease contract include Operating Lease, Financial Lease, Direct Lease, Sale and Lease Back and Leveraged Lease.
Every lease has a “start date,” but many people, accountants included, do not understand what that date really is or how to find it. When precisely does a lease start? Is it the execution date? The move-in date? The date the company opens for business at the location?
The lease start date and how to determine it
The lease start date is the date that possession is passed from the landlord to the tenant. On that date, the lessee, or tenant, should begin recording straight-line rent expense even if that date is earlier than the “commencement date” specified on the lease. Under both ASC 840 as well as the new lease accounting rules, the commencement date specified on the lease document has no bearing whatsoever on the lease start date.
However, the commencement date specified on the lease document may be used to determine the lease end date. This is because, most of the time, the “lease term” specified on the lease document “starts” on the commencement date. So, if the commencement date in a lease document was January 1, 2020 and the lease term specified in the document was 24 months, then the lease end date would be January 1, 2022.
Download our 12-step lease accounting guide to ASC 842 and IFRS 16 transitions:
Finding a lease start date in lease document language: Two examples
You’ve probably seen language in a lease as follows:
Lease Term: A term commencing on January 1, 2016 (Commencement Date) and continuing for sixty-six (66) full calendar months. Tenant shall be granted access to the Premises sixty (60) days prior to the Commencement Date to install equipment and furnishings (the “Early Access Period”). Such access shall be subject to all the terms and conditions of this Lease, except that the Commencement Date and the payment of Rent shall not be triggered thereby.
Based on the language above, for accounting purposes, the lease start date in the example is actually November 1, 2015 (or whenever access is granted), and the lease term is actually 68 months. The tenant would record expense in the months of November and December (the offset is to deferred rent), even though the lease explicitly asserts that the commencement date is January 1, 2016.
Here’s a second example:
The Lease Term shall be for a period of one hundred twenty (120) months commencing one hundred fifty (150) days after the date upon which Tenant Opens for business at the Demised Premises (the “Commencement Date”).
In this example, assuming the tenant takes possession of the premises on January 1, 2016 (to construct leasehold improvements) and opens for business on June 1, 2016, then the commencement date per the lease document is November 1, 2016. However, for accounting purposes, the lease start date is actually January 1, 2016 (the possession date), and the tenant would have to record expense for January through October 2016, even though the lease asserts that the commencement date is November 1, 2016. Additionally, the accounting lease term is actually 130 months, as opposed to 120 months as stated in the lease.
So there you have it; now you know the difference between the commencement date as stated in a lease and the lease start date for accounting purposes. As you are comparing reviews and making decisions on your lease accounting software, make sure to ask vendors if their software solutions track both the commencement date as well as the possession date. Also ask if the software amortizes rent expense from the possession date and not the commencement date. LeaseQuery accounting software performs these functions effortlessly.
As a pandemic spread across the globe in early 2020, commercial tenants and landlords began renegotiating lease terms and conditions as stores, restaurants, and other commercial venues shuttered. In some cases, rents have been deferred and rent concessions made to offset an unprecedented drop in income, which raises the question: How are these rent concessions supposed to be accounted for?
What complicates matters further in these COVID-19 rent concessions is the need to remain compliant with all the accompanying lease accounting standards. FASB and IASB have both issued guidance on how to account for COVID-19 concessions, but certain complexities remain.
When should COVID-19 rent concessions be treated as lease modifications?
According to the guidance from FASB and IASB, a COVID-19 concession can be accounted for in one of two ways: either as a lease modification or not as a lease modification. If it is determined that the original terms of the lease agreement contained no obligation by the lessor to grant any COVID-19 rent concession, then that concession is a lease modification. But if you identify enforceable rights to the concession in the original contract, such as force majeure language, then that rent concession is not a lease modification.
In many cases, making these determinations may not be clear cut, so some legal assessment may be required. Considering that making this evaluation for every single lease in your portfolio might seem like a grueling task, there are some practical expedient elections to be found in the FASB and IASB guidance in this area.
What to do if you receive a COVID-19 rent concession
In the event that you do receive a COVID-19 rent concession, it’s important to have procedures in place that will ensure proper communication and coordination among the stakeholders within your organization, such as lease administration, lease accounting, and accounts payable operations.
Unfortunately, there is no “one size fits all” solution for your entire portfolio. Assessing next steps when receiving a COVID-19 concession may require it to be applied differently to each one of your leases. How you account for a COVID-19 concession will mostly depend on these three factors:
- Which accounting elections you make about (a) evaluating if a lease contract contains provisions for the COVID-19 Concession (both FASB & IASB) and (b) whether to treat the COVID-19 Concession as a lease modification or not a lease modification (FASB only).
- How you code the COVID-19 Concession in your A/P system.
- What General Ledger account you credit when you record the monthly Lease Liability amortization and interest on the Lease Liability.
Other critical questions about COVID-19 concessions
Even beyond these general guidelines, you might still be left with questions about your specific circumstances, or about what might or might not constitute a lease modification. While the FASB and IASB guidelines are readily available for review, MRI Software has assembled a rent concessions guide for lessees that drills straight down to the questions you may have and provides several examples of what COVID-19 concession journal entries look like.
Tony Famularo is Director Technical Accounting at ProLease Software, An MRI Software Company.
Larry Lazerwitz is Director Technical Accounting at ProLease Software, An MRI Software Company.
Historically, accounting for lease modifications is an area you may have found an infrequent need to address. The COVID-19 pandemic has upset that general rule, with lease concessions and terminations becoming all too common to afford relief to lessees under difficult economic conditions and disruptions. These adverse circumstances have served to place a spotlight on the necessity for entities to have processes and systems in place to account for lease modifications properly
Because many companies were forced to reduce on-site employees or to ask employees to work from home, the necessity for leased space significantly decreased in 2020 and into 2021. As restrictions are lifted in some areas, some companies are allowing their employees to return to the office and are requiring additional leased space once again, while others have decided to permanently reduce their real estate footprint and expenses. With these volatile changes affecting both the economy and how entities conduct their business and with the impending implementation of the new leases standard for private companies, many are asking, “How should we account for lease modifications under ASC 842?”
First, let’s consider the key questions for typical modifications under ASC 842, Leases.
Leases are contracts and have specific performance rights and obligations. If circumstances or agreements between the lessee and lessor require modifications, you should first determine if the lease contract already considered the changes at issue. If the initial contract provided for the relevant changes, modification accounting would not be applied under ASC 842 (or ASC 840). You also have to consider if the modified contract remains a lease. If a lease still exists, the modification could be accounted for in the following ways:
- A change to the accounting for the existing lease; or,
- A separate, new contract and the unchanged existing lease.
When the modification meets both of the following criteria, lessees and lessors account for the changes as a new, separate contract:
- The lessee obtains an additional right of use not included in the current lease.
- The additional right of use has a commensurable increase in the lease payments, taking the circumstances of the contract into account.
Modifications that are not treated as separate contracts will require you to reassess the lease classification and lease term as of the effective date of the modification and account for any initial direct costs, lease incentives, or any other modification-related payments using the same principles as if this were a new lease.
Using the rate implicit in the lease, if known, or more likely the incremental borrowing rate as of the effective date of the modification, the lessee is required to reallocate the remaining consideration, remeasure the lease liability, and adjust the right-of-use asset(s) if the modification results in any of the following conditions:
- The lessee obtains an additional right-of-use that is not included in the original lease nor accounted for as a separate contract.
- The lease term is changed.
- The lease is partially or fully terminated (which may result in a gain or loss for any difference in reduction of the lease liability as compared to the reduction of the right-of-use asset).
- The consideration only is changed in the lease.
If the lease classification is reassessed from a finance lease to an operating lease, a difference between the right-of-use asset carrying value after the aforementioned adjustments and the carrying value resulting from measurement under initial operating lease guidance would be treated in the same way as prepaid rent or a lease incentive.
If a modification is not considered as a separate contract, the accounting for a lessor depends on the classification of the original lease as compared to the reassessed classification of the modified lease as of the effective date of the modification.
Next, let’s address modification accounting considering the types of concessions afforded to lessees that are specifically related to the COVID-19 pandemic and the corresponding relief that the FASB offered as an accounting policy election to ease accounting burdens on those affected by the adverse impacts of the pandemic.
Effects of the COVID-19 Pandemic
With lessees suffering the financial impacts of the pandemic, many were unable to make payments according to their lease agreements. In response, some lessors offered lease concessions, most commonly in the form of payment forgiveness or deferrals, to lessees to maintain the business relationship and to reap any possible income. Under ASC 842 lease accounting, modifications that require accounting as if it were a new lease are assumed to affect the remaining lease term. This isn’t always the case when many are anticipating that the concessions won’t be long-term, but rather only temporary relief. So will you apply modification accounting for lease concessions that won’t reasonably affect the entire lease term?
The Financial Accounting Standards Board (FASB) issued the FASB staff question-and-answer document (Q&A) on Topic 842 and Topic 840: Accounting for Lease Concessions Related to the Effects of the COVID-19 Pandemic in April 2020 to address the concerns and implementation efforts and costs associated with accounting for leases that are “directly affected by the economic disruptions caused by the COVID-19 pandemic” and that “do not result in a substantial increase in the rights of the lessor or the obligations of the lessee.”
Citing the unprecedented global nature of the pandemic, the lack of specific guidance to address the resulting circumstances, and the challenges presented in time and costs to analyze and account for possibly a great magnitude of lease modifications within an entity, FASB made it possible for entities to make an accounting policy election to assume any concessions related specifically to the COVID-19 pandemic are explicitly stated as enforceable rights and obligations within a lease, whether they are explicitly stated or not.
As a result of making this policy election, you would not have to analyze each lease contract and could elect to apply or not to apply lease modification accounting under ASC 842 (or ASC 840). The policy election must be applied to similar leases with similar circumstances in a consistent manner.
Consider using a Leases Toolkit to assist you in your implementation and application of the new FASB Codification Topic 842, Leases, and to ensure that you have good process and documentation.
Accounting standards require lessees to recognize a right of use asset and associated lease liability for almost all leases. Lessors, on the other hand, are required to classify leases into operating leases and finance leases and recognize finance lease receivable only in respect of finance leases.
Lease accounting has underdone significant changes due to introduction of the new lease accounting standards (IFRS 16 and ASC 842). Earlier, both lessees and lessors were required to classify their leases based on whether they transfer significantly all risks and rewards incidental to ownership. Under the new accounting standards, whether a party recognizes an asset and/or liability arising from a lease depends on whether the party is a lessee or a lessor and if lessor, whether the lease is a finance lease.
Accounting by lessees
The new accounting standards require a lessee to capitalize almost all leases on its balance sheet. Leases result in recognition of both an asset (often referred to as a right of use asset) and a lease liability in the books of the lessee at the commencement date.
The lease liability is measured at the present value of lease payments which mainly comprise of all fixed payments and variable payments which are linked to some index or rate. The right of use asset is measured at cost.
PMA, Inc. is a rail company which has leased out diesel generators from GP, Ltd. to provide backup to the transportation system during power outages. The lease has 5-year term in which PMA must make $500,000 payment to GP at the end of each year. Journalize the transaction at the commencement date of the lease and the first payment made by PMA in the books of the PMA and GP if PV of lease payments is $1,996,355 and rate of interest implicit in the lease is 8%.
Since the lease liability equals the present value of lease payments, and there are no initial direct costs, etc., the lessee shall record the transaction as follows
|Right of use asset||$1,996,355|
After initial recognition, a lessee increases the lease liability by recognize interest expense on the lease liability and decreases it by the payments it made during the periods. A lessee typically prepares a lease amortization schedule.
In the example above, at the time of first annual payment, the lessee records the following journal entry:
|Interest expense ($500,000 × 8%)||$40,000|
Subsequently, the lessee accounts for the ROU assets just like an owned/acquired asset. It recognizes depreciation expense and impairment losses, if any, on the ROU asset. in accordance with its policy for fixed assets.
Capitalization of a lease results in front-loading of expense, i.e. higher expense is recognized in earlier periods.
Accounting by lessors
A lessor is required to first determine whether a lessee is an operating lease or a finance lease. Only finance leases are required to be capitalized on balance sheet.
The lessor shall record the start of a lease by creating a lease receivable at its net investment in lease, which is equal to the lease payments discounted at the rate of interest implicit in the lease.
A lease is either:
- a finance lease (also called capital lease in the US GAAP) in which the risks and rewards inherent in the asset are transferred to the lessee.
- an operating lease in which the risks and rewards inherent in the asset are not transferred to the lessee.
Other classifications include: sales-type lease and direct financing lease.
Substance-over-form principle is applied to determine whether risks and rewards have transferred or not; which means that transfer of legal ownership is not very relevant in deciding whether a lease is an operating lease or a finance lease.
Since a finance lease involves transfer of risk and rewards, the leased asset is recorded in the books of the lessee together with a corresponding lease liability. The leased asset is recorded at the present value of minimum lease payments (or fair value if it is lower). The present value of lease payments is determined using the rate of interest implicit in the lease (or the lessee’s incremental rate of return if the interest rate implicit in the lease is not available).
Journal entries in case of a finance lease
Following the example above, if we determine that the lease is a finance lease, the lessor shall pass the following journal entry at the start of the lease contract:
At the time of first payment, lessor shall record receipt of cash, reduction in lease receivable and recognition of finance income:
|Lease receivable ($500,000-40,000)||$460,000|
|Finance income ($500,000×8%)||$40,000|
The reduction in lease receivable reduces the principal balance in lease receivable (also called net investment in lease) to $1,536,355, which shall reduce the next year finance income.
Journal entries in case of an operating lease
If a lessor determines a contract to contain only an operating lease, it is not required to recognize any asset or liability. The lease income is recognized on a basis reflecting the use of the asset.
If the contract in the example discussed above is determined not to contain a finance lease, no journal entry shall be made the start of the lease contract. The lessor continues to recognize and depreciate the leased asset on its balance sheet.
During the first year, the lessor shall recognize receipt of lease rental as follows:
Lease termination is when a lessee or lesser decide to break the lease agreement before the agreement is over. There can be several reasons for terminating the lease. For example, the tenant might terminate it because of the conditions of the rental property, safety concerns, privacy violation, and additional charges. The landlord might also desire to terminate the lease because the payments are not made or there are structural damages, illegal activities, or noise nuisance.
The lease agreement usually provides for notice requirements in case of termination, any penalties that might need to be paid, or an option to change the agreement terms. In any case, both will need to make records of this termination in their accounting books and we will guide you through the process.
What Lessee Should Know
If the entity leasing the asset decides to fully terminate the lease agreement, the business would need to derecognize the full lessee’s right to hold, operate, or occupy a leased item and a liability associated with the lease. To determine how this discontinuation will be reflected on its Income Statement, the business will gage the difference between asset account balance and liability account balance associated with this lease. The result might be positive or negative, which will translate into a loss or gain for the business. It should be noted that the lessor might request the entity to pay a penalty as specified in the agreement. This penalty would need to be accounted for when calculating the loss or gain.
The lease discontinuation might also occur due to the fact that the lessee is able to buy the leased asset. The way this termination would be recorded in the business books will depend on what accounting standards it follows. For example, under the IFRS, the business will record the termination of the lease will be recorded as a gain or loss. This will be determined based on the reassessment of the lease liability account and the lease asset.
If the company adheres to the GAAP and buys the leased asset, it is not considered a termination. Thus, the business would record it as a purchase of a new asset. The value of this asset will be calculated by adding the difference between the remaining lease liability and the purchase price when the asset is bought to the leased asset carrying value. With GASB, one would just recognize the intangible lessee’s right to hold, operate, or occupy a leased item as a tangible asset.
What Lessor Should Know
The termination process for lessor is very similar to that of a lessee. If the lease is fully terminated, the lessor would completely derecognize any lease assets, such as the associated amount in Lease Receivable account, and/or lease liabilities, such as unamortized initial direct costs and rent receivable. Just like lessee, to determine how this termination will be reflected on the lessor’s Income Statement, it will calculate the difference between Lease Asset account balance and the Liability account balance on the date of the lease termination. The lease can also be terminated partially. We will discuss this next.
Partial Lease Termination
There is also an option to terminate the lease only partially. The way one would record this type of termination will depend on the accounting standards the company adheres to. Let’s review the most common ones.
- According to the International Financial Reporting Standards, the liability and asset value should be changed to accurately represent the partial lease discontinuation. Any difference will be recorded in the Income Statement for the period as gain or loss.
- If the Generally Accepted Accounting Principles are used as a guide, then one of the methods to reflect the change would be to make a proportionate adjustment in the right-of-use asset value based on the reduction in the liability. As in any other case, the difference between the two would be noted on the financial statements as gain or loss.
- The Governmental Accounting Standards Board, on the other hand, requires to measure both the liability and the asset again according to the new payment terms and apply the liability adjustment amount to the asset to show the change. Any variations will be considered a loss or gain.
As you can see, there are many nuances around the discontinuation of lease. The details might vary based on the specifics of lease terms, accounting standards and requirements, as well as other factors. If you do not have previous experience with this, we recommend turning to a knowledgeable accountant for assistance and guidance.
The recording and tracking of Capital and Operating Leases is somewhat complicated and the University is required to be in compliance with Financial Accounting Standards Board (FASB) Statement No. 13 and Government Accounting Standards Board (GASB). This guide is not intended to go through the entire behind-the-scenes analysis of how to record leases, but rather provide guidance on the day to day Department and Controller’s Office processes as it relates to equipment.
Capital Lease or Installment Purchase Lease
A Capital Lease or Installment Purchase is a lease in which the University executes a written contract with another party through Campus Procurement and Contracts to purchase personal or real property with scheduled specific installment payments of money during the life of a contract. Title to the property remains with the lessor until the total contract amount has been paid. The University has the right to take possession of the property at the end of the contract, or earlier, subject to payment of any outstanding principal and the buy-out amount specified in the contract.
If the current market value is $100,000 or more it qualifies as a Capital Lease. Below $100,000 it is classified as an Installment Purchase.
Characteristics of a Capital Lease or an Installment Purchase Lease
- Has specific beginning and ending dates
- Interest rate is stated and fixed for the life of the lease
- Almost always has a buyout amount (sometimes this will be for $1 only)
- Provides for transfer of ownership upon payment of the lease and payment of the agreed buy out amount
- Period of lease is at least 75% of the estimated economic life of the equipment
- Present value of the lease payments is as least 90% of the fair market value of the equipment
- Amount of the installment payment will be noted on the lease contract
- Lease is non-cancelable
The Payment Process
- Campus Procurement creates the Purchase Order which establishes the payment amounts, duration and interest.
- Capital Accounting has responsibility to:
- Set-up of the Capital Lease in PeopleSoft Asset Management
- Enter the lease invoice into the PeopleSoft Accounts Payable module
- Divide the payment into principal and interest based on the amortization schedule
- Classify the principal and interest components to the correct Account pairs below:
Cap lease – non-comp
Cap lease – computer
- If sales tax was not paid by the lessor when the financing occurred, Capital Accounting will add Use Tax to the monthly payment.
- In general, a copy of the monthly invoice is not sent to the department for review or approval. Approval is implied when the purchase order is authorized. Lease payments must be made according to the scheduled due dates established in the purchase order and contract terms. The Controller’s Office has the signed Purchase Order and Contract on file which provides the department’s agreement to the monthly payment.
- Questions concerning Capital Lease payments should be directed to Capital Accounting at 415.502.3042.
The Year End Closing Process for Capital Lease/Installment Payments in the General Ledger
As stated in the introduction, we are required to record leases according FASB, GASB and University guidelines. The end result is that at the end of the year we are required to reclassify both the principal and interest payments made within the fiscal year to Equity. At a high level the following outlines the process:
- The total principal and interest payments made to the Accounts in the chart above during the year are accumulated for each lease by Fund/Dept ID/Project./Activity Period/Function
- Journals are created as follows:
Financial Journal (SC 566)
- Principal and Interest (Lump Sum) – Debit Transfer Account, Fund, Dept ID, Project, Activity Period, Function
- Principal – Credit Account (see chart below), Fund, Dept ID, Project, Activity Period, Function
- Interest – Credit Account (see chart below), Fund, Dept ID, Project, Activity Period, Function
YE recl cap leas non-comp
YE recl cap lease comp
Note: The Accounts above are reserved for Controller’s Office use only.
- End result of the above transactions does not affect the overall chartstring balance.
- Reclass Accounts eliminate manual recalculation and adjustment of Facilities and Administrative Cost (F&A) by the Controller’s Office when closing out grants and contracts.
- Principal Payments are exempt/excluded from F&A for base codes where equipment purchases are exempt from F&A.
- Interest Accounts are not exempt/included in F&A for base codes where supplies and service costs are allowable for F&A.
Other Types of Leases or Contracts
This is a straight lease of equipment. There is no expectation that the University will take possession of the equipment at the end of the lease.
- There may or may not be a beginning and ending date of the lease and it can be extended with a Change Order issued by Purchasing Services.
- There may be a buyout option and if so, the price is generally the fair market value of the equipment.
- This is no interest associated or accrued as there is with Capital Leases.
- All payments are made to Account 57601 – Operating lease payments.
- There are no year- end reclassifications of payments as is done for Capital Leases.
- Operating Leases are considered as an operational cost.
- Questions concerning Operating Leases should be directed to your Supply Chain Management buyer.
Repair and Maintenance Contract
This is a contract for the repair and maintenance of equipment and is not considered as part of a Capital Lease or Installment Purchase. A monthly payment is made by Campus Accounts Payable. The contract may be extended with a Change Order from Campus Procurement and Contracting. Payments are charged to the following Account:
Cost per Copy Contract
This is a contract for the use of a photocopier based on the number of copies made each month. This contract is similar to a repair and maintenance contract. This is no expectation of ownership at the end of the contract. Payments are charged to the following Account:
Issued April 1984. Effective 1 July 1984. Amended February 1997.
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SSAP 21 has been superseded by FRS 102 The Financial Reporting Standard applicable in the UK and Republic of Ireland for accounting periods beginning on or after 1 January 2015. For more information visit:
SSAP 21 prescribes the accounting for:
- Finance leases, and
- Operating leases
The accounting treatment of a finance lease in the lessees accounts is:
- Record as an asset in the balance sheet and as an obligation to pay future rentals
- Rental payments should be apportioned between the finance charge and a reduction in the obligation
- The total finance charge should be allocated to accounting periods so as to produce a constant periodic rate of return on the remaining balance of the obligation.
The rental for an operating lease should be charged by the lessee on a straight line basis over the lease term. The asset is not capitalised by the lessee.
The accounting treatment for lessors is effectively the mirror image of that for lessees:
- For a finance lease record amount due from lessee in the balance sheet as a debtor
- Allocate gross earnings to each accounting period in order to give a constant periodic rate of return on net cash investment
- For an asset held under an operating lease the lessor should record as a fixed asset in the balance sheet and depreciate the asset.
Sale and leaseback transactions are accounted for according to the type of lease and amount of sales proceeds in comparison to fair value.
When two parties enter into a lease contract, they negotiate different terms. One of the common ways lessors use is to offer incentives or allowances to the lessees.
A lease incentive reduces the lease liability for the lessee. It should be recognized under ASC 842 if it meets certain criteria.
Accounting for the lease incentive is fairly simple. Both parties can use the same judgment basis to recognize the lease incentive in their respective account books.
What is a Lease Incentive?
A lease incentive is a payment made by the lessor directly to the lessee or on behalf of the lessee. These payments are linked with underlying asset expenses usually.
A lessor may make such incentive payments to make the lease terms more appealing to the lessee. These payments can be made on or after the commencement date of the lease contract between the two parties.
- Cash payment from the lessor at the commencement date to the lessee.
- Reimbursement of expenses incurred by the lessee for the underlying asset improvements.
- Prepaid expenses by the lessor on behalf of the lessee that relate to the lease contract.
A lease incentive can take several forms. However, in either case, the lease incentive will reduce the lease liability expense for the lessee or the lessor. Both parties will recognize the lease incentive in their respective account books accordingly.
Accounting for Lease Incentives under ASC 842
The lease incentive is recognized and recorded in the account books under ASC 842. The lease incentive should be recorded using the straight-line expense method for an operating lease.
In some cases, the lease contract may include the terms relating to the asset improvements or other related expenses. Otherwise, it should be assessed whether the expense relates to the asset of the lessee or the lessor.
- The lessee receives any allowance or incentive amount in excess of the asset improvement expenses.
- The lessee can use the received fund discretely for the underlying asset.
- Lessee has an obligation to install the asset in a certain condition.
- The Lessee cannot alter asset improvements without the prior consent of the lessor.
- Lessor will receive significant residual value of the asset at the end of the lease contract.
Lease incentive expenses should only be recognized if they belong to the lessee asset meeting one of the conditions stated above.
Leasehold Expenses – Lessor Asset
If any expenses related to the underlying asset are determined to be the lessor asset meeting the conditions stated above, it will not be recorded as a lease incentive under ASC 842.
The lessee will only record such reimbursement from the lessor as a prepaid rent/lease expense. For example, the contract stated a condition to the lessee for certain asset improvement that resulted in a $ 3,000 cost.
The lessee will receive the reimbursement from the lessor. The lessee will record $3,000 as a prepaid lease payment.
Leasehold Expenses – Lessee Asset
If the leasehold expenses incurred are determined to be the lessee asset, then they will be recognized as lease incentives.
The lease incentive is recognized under ASC 842 – 10-30-5 and 842-10-15-35.
Total Lease Contract Payment = lease payments + fixed payments + variable payments – lease incentive payments.
A lease incentive will reduce the lease payment for the lessee. The lease incentive amount should be amortized using the straight-line allocation method.
The ASC 842 does not provide clear directions for any lease improvements or expenses not paid or payable.
Both parties can use professional judgment to recognize such expenses when they incur. However, there should be a reasonable judgment for the timing and amount of the payable expense.
Let us understand the concept with the help of a simple working example.
Suppose a company ABC is a leasing company of manufacturing equipment. Another company XYZ is interested in leasing manufacturing equipment.
- Lease term is 5 years
- Annual Lease payment: $ 50,000
- Lease Incentive Amount: $ 30,000 received at commencement of lease.
- Interest Rate: 5%
Under the ASC 842 – 20-30-1, the lease payments not paid yet should be recorded at present values.
The next step is to calculate the Right of Use (ROU) value of the leased asset.
- Initial lease payment measurement
- Any amount paid to the lessor less any lease incentives
- Indirect costs incurred by the lessee on the leased asset
The company XYZ received a lease incentive of $ 30,000 from ABC (lessor). Hence, it will be deducted from the NPV of lease amount ($ 216,500 – 30,000 = $ 186,500).
Amortized Lease Incentive over 5 years = 30,000/5 = $ 6,000.
It means the company XYZ will be actually making a lease payment of $ 44,000 to the lessor ABC yearly.
Finally, the last step is to record the journal entry for the total lease liability account that is offset by the ROU amount account.