Did you ever wonder why accountants always refer to leasing as off-balance sheet financing? And why is there always so much debate about whether leases should be capitalized? Well, there are two schools of accounting thought on how to treat leases, and they both have advantages and disadvantages.
The first school of thought suggests that leases should be treated as operating expenses. It means the lessee would record all lease payments as expenses on their income statement. The advantage of this approach is that it is simpler and more accurately reflects the company’s cash flow. The disadvantage is that it does not give an accurate picture of the company’s assets and liabilities.
The second school of thought is that leases should be capitalized. It means the lessee would record the lease payments as assets on their balance sheet. The advantage of this approach is that it gives a more accurate picture of the company’s assets and liabilities. The disadvantage is that it is more complex and does not accurately reflect the company’s cash flow.
So, which approach is better? It depends on what information the company wants to communicate. Every professional accountant knows that lease accounting can be very complex. For those of us who are new to the field, it can be downright confusing. This guide will give you a basic understanding of lease accounting and its workings.
1. Leases can be either operating or capital.
Operating leases, such as office space or equipment, are typically used for short-term rentals. The lessee records all payments as expenses on their income statement. This treatment is simple and easy to understand, but it does not give an accurate picture of the company’s assets and liabilities. You can refer to the ASC 842 guide to learn about operating leases. The ASC 842 lease accounting standard relates to compliance with operating leases. On the other hand, capital leases, such as vehicle financing, are used for long-term rentals and usually result in ownership of the leased asset.
2. The goal is to give a true and fair view of the company.
The new lease accounting standard requires that all leases be included on the balance sheet. It will allow investors and other financial statement users to make more informed decisions. The goal is to give a true and fair view of the company by providing transparency into its leasing activities. The more you know about the company, the better you’ll be at making decisions about it.
3. There are two types of lease classification: finance and operating.
The new lease accounting standard requires that all leases be classified as either finance or operating. Basically, finance leases are those in which the risks and rewards of ownership are transferred to the lessee. The lessor only retains title to the leased asset for the duration of the lease. On the other hand, operating leases do not transfer ownership to the lessee. However, there is an exception for short-term leases with terms of 12 months or less.
4. The amortization schedule is different for finance and operating leases.
The operating lease payments are recorded as expenses on the income statement, while the finance lease payments are capitalized on the balance sheet. The lessee will amortize or write off the capitalized payments over the life of the lease. This treatment is more accurate because it matches the timing of the expenses with the use of the leased asset. However, it can be more complex to understand and calculate. And the reason for this is that, as we mentioned before, the ASC 842 compliance guide refers to the accounting for finance leases.
5. There are two methods of lease accounting: the straight-line method and the sum-of-the-digits method.
The straight-line method is the most common method of lease accounting. Under this method, the asset is amortized over the life of the lease, and the liability is not amortized. The sum-of-the-digits method is less common, but it is allowed under the new lease accounting standard. You can always consult your accountant to determine the best method for your company. However, switching methods is always possible if it is in the company’s best interest.
6. Lease accounting can be complex, but it’s essential to get it right.
The new lease accounting standard is complex, but it’s important to get it right. The goal is to give a true and fair view of the company by providing transparency into its leasing activities. This will allow investors and other financial statement users to make more informed decisions. The more you know about the company, the better equipped you’ll be to make decisions about it. Furthermore, the new standard will make it easier to compare companies across industries because they will all be using the same accounting method.
7. There is a lot of transition relief under the new standard.
There is a lot of transition relief under the new lease accounting standard. This means that companies have time to adjust to the new requirements. However, early adoption is allowed. This will give them more time to get everything in order and ensure they are in compliance.
8. There are some important exceptions to the new lease accounting standard.
There are some important exceptions to the new lease accounting standard. The most notable exception is for short-term leases with terms of 12 months or less. These leases will not be classified as a finance or operating leases. Another exception is for leased assets that are used for business purposes only. These assets will not be included in the lease accounting.
Summary
Numbers and accounting might not be the most exciting thing in business. But they are essential to understand if you want to make informed decisions about your company. The new lease accounting standard is no different. Understanding how it works and what it means for your business is important. With this knowledge, you’ll be better equipped to make decisions about your company’s leasing activities.
Moreover, you’ll be able to provide transparency into these activities to investors and other financial statement users. This will allow them to make more informed decisions about your company. Finally, the new standard will make it easier to compare companies across industries because they will all be using the same accounting method.
