Lease accounting is an essential aspect of reporting for companies.
Lease accounting is an essential aspect of financial reporting for companies that lease assets, such as real estate, equipment, and vehicles. The Financial Accounting Standards Board (FASB) introduced a new accounting standard, ASC 842, that replaces the previous lease accounting standard, ASC 840. ASC 842 aims to improve the transparency and comparability of lease accounting for both lessees and lessors.
ASC 842 requires lessees to recognize lease assets and liabilities on their balance sheet for all leases with terms longer than 12 months, regardless of whether the lease is classified as a finance or operating lease. The lease liability represents the lessee's obligation to make lease payments over the lease term, while the lease asset represents the right to use the leased asset for the lease term.
Here's a step-by-step guide to lease accounting under ASC 842:
Step 1: Identify the lease
The first step in lease accounting under ASC 842 is to identify whether a contract contains a lease. A lease is defined as a contract that conveys the right to control the use of an identified asset for a period of time in exchange for consideration. The contract should be evaluated at the inception of the lease and reassessed if the terms of the contract change.
Step 2: Determine the lease term
The lease term is the non-cancellable period for which the lessee has the right to use the leased asset, including any renewal options that the lessee is reasonably certain to exercise. If the lessee can terminate the lease before the end of the lease term, the lease term should be the non-cancellable period plus any termination options that the lessee is reasonably certain not to exercise.
Step 3: Calculate the lease payments
The lease payments are the fixed and variable payments that the lessee is obligated to make over the lease term, including any initial direct costs and any lease incentives received from the lessor. Variable lease payments should be estimated based on the lessee's best estimate of the payments over the lease term.
Step 4: Determine the lease classification
Under ASC 842, leases are classified as finance leases or operating leases based on the extent to which the lease transfers control of the underlying asset to the lessee.
A finance lease is a lease that transfers control of the underlying asset to the lessee, and the lessee has the right to obtain substantially all of the economic benefits from the use of the asset. The lease liability should be measured at the present value of the lease payments, and the lease asset should be measured at the same amount as the lease liability, adjusted for any lease incentives and initial direct costs.
An operating lease is a lease that does not transfer control of the underlying asset to the lessee. The lease liability should be measured at the present value of the lease payments, and the lease asset should be measured at the same amount as the lease liability, adjusted for any lease incentives and initial direct costs.
Step 5: Recognize and measure the lease liability and lease asset
The lease liability and lease asset should be recognized on the lessee's balance sheet at the lease commencement date. The lease liability should be initially measured at the present value of the lease payments, and the lease asset should be initially measured at the same amount as the lease liability, adjusted for any lease incentives and initial direct costs.
Step 6: Account for subsequent lease payments
The lessee should remeasure the lease liability and lease asset at each reporting date to reflect the remaining lease payments, any lease modifications, and any reassessments of the lease term or classification. The lessee should recognize interest expense on the lease liability and amortization expense on the lease asset over the lease term.