Lease Accounting Terms

Terms to Know for the New Lease Accounting Standards

ASC 842

ASC 842 replaces FASB’s previous lease accounting guidance, ASC 840. Companies reporting under US GAAP will be required to transition to ASC 842 starting January 2019. The major change resulting from the new standards is that operating leases, previously reported in the footnotes of financial statements, will now be reported on-balance sheet. The change requires companies to commit to a higher level of data tracking for their operating leases.

For more information, read the FASB update here.

Asset-Level Lease Accounting

Accounting for leases at the asset level is required by ASC 842 and IFRS 16. Asset-level accounting is the process of recording transactions by generating debits and credits for each asset on a lease, rather than only for the lease as a whole. FASB and IASB are requiring asset-level lease accounting in order to better track companies’ operating lease portfolios.

Many events that alter lease accounting can occur at the asset level. For example, any change to the factors that determine present value of an asset, including a change to the asset term from a partial buyout, return, or renewal; differences in the residual values; or differences in lease rate factors, will alter the accounting.

To learn more, read this Asset-Level Lease Accounting White Paper.

Classification

Under the old FASB standard (ASC 840), leases were classified as either capital or operating leases. Capital leases were reported on the balance sheet, operating leases were reported in the footnotes. Under the new FASB standard (ASC 842), the classification criteria hasn’t changed much, but now capital leases are called finance leases. However, now all leases over 12 months in length will have to be reported on the balance sheet, regardless of how they’re classified.

Meanwhile, IASB’s new standard, IFRS 16, gets rid of classification criteria all together. Instead, IFRS 16 treats all leases longer than 12 months in length and more than $5000 in value as finance leases.

Read more about ASC 842 lease classification from Bloomberg BNA here.
Read more about identification of a lease under IFRS 16 from IASPlus here.

Embedded Leases

Embedded leases are one of the most difficult parts of the new standard. The term refers to leases that are embedded within service contracts, outsourcing agreements, or other arrangements, but may not be explicitly called leases. To determine if an embedded lease exists, determine whether there is an asset specified (explicitly or implicitly) and if the lessee controls the use of the asset. If both are true, then a lease exists. For example, the energy industry often uses pipelines to transfer oil as part of a transportation agreement. If the pipeline is considered an asset under the new standards, then that agreement would contain an embedded lease.

To learn more, read the PwC guide on embedded leases.

Enterprise Lease Accounting Software

Enterprise Lease Accounting (ELA) is a new category of software. ELA solutions are used to help companies maintain accounting compliance for their leases. In the past, leasing – especially equipment leasing – has been a decentralized process at many companies. However, with the introduction of the new accounting standards, ASC 842 and IFRS 16, companies will be required to track their lease data more closely than ever before in order for their lease accounting to hold up under increased auditor scrutiny. ELA applications are designed to help companies maintain compliance under the new (and current) lease accounting standards.

To learn more about what features to require in an Enterprise Lease Accounting application, check out this guide.

Finance Lease

Finance leases are replacing capital leases under ASC 842. The main criteria for an asset to be considered a finance lease is that ownership of the asset transfers to the lessee, along with the risks and rewards of ownership. Finance leases are reported on the balance sheet. As with capital leases, the interest and amortization for a finance lease are reported as separate line items on the income statement. Under IFRS 16, all leases over 12 months in length and greater than $5000 in value will be treated as finance leases.

IFRS 16

IFRS 16 replaces IASB’s previous lease accounting guidance, IAS 17. Companies reporting under IFRS will be required to transition to IFRS 16 starting January 2019. The major change resulting from the new standards is that there will no longer be a distinction between operating and finance leases. Instead, all leases that are longer than 12 months and more than $5000 in value must be reported on the balance sheet. The change requires companies to commit to a higher level of data tracking for all of their leases.

Read more about IFRS 16 at the official IASB page here.

Operating Lease

An operating lease will not convey rights of ownership to the lessee, and often has a shorter term than the economic lives of the assets on the lease.

Under the current FASB lease standards, ASC 840 operating leases are only disclosed in the footnotes of financial statements as “off-balance sheet” operating expenses and excluded from important financial ratios, such as return on assets.

However, under ASC 842, companies will be required to report operating leases on the balance sheet. The way operating leases are reported on the income statement will not change. IFRS 16 removed the distinction between operating and finance leases, so now all leases longer than 12 months in length and greater than $5000 in value will be treated as finance leases.

Options

Leasing contracts often provide options to be exercised during the middle or the end of the lease term. Those options can include full or partial returns, renewals, or buyouts for equipment assets, and expansions, contractions, or renewals for real estate assets. Under the new accounting standards, the reasonably certain end-of-term option must be recorded at the beginning of the lease.

Lease Accounting Subledger

Subledgers contain detailed transactions from certain accounts, which can later be consolidated and loaded into a general ledger. Subledgers are frequently used by organizations like Accounts Receivable and Accounts Payable and for accounting processes like preparing a trial balance and reconciling the general ledger accounts. Auditors also use subledgers to validate a company’s financial statements.

With the introduction of the new accounting standards, lease accounting subledgers are growing in popularity. Since companies need to track their right-of-use assets and lease liabilities on the balance sheet, those with large lease portfolios will need to utilize a subledger capable of tracking leases at the asset level. The lease accounting subledgers can later be aggregated to the schedule or portfolio level for transfer to the general ledger.

To learn more, read this blog about lease accounting subledgers.