Lease Accounting

What is a Finance Lease?

Overview

A finance lease, known as a capital lease under ASC 840, is an accounting lease classification used by international and US standards. Leases can also be classified as operating. Both international and US standards require different accounting treatment for the two classifications.

Current Lease Accounting Standards

Under current accounting standards, IAS 17 and ASC 840, finance/capital leases are capitalized on the balance sheet. They are reported as an interest and depreciation expense on the income statement. However, operating leases, on the other hand, are not capitalized on the balance sheet. Instead, they are straight-line expensed on the income statement.

New Lease Accounting Standards

However, in 2016 the International Accounting Standards Board and the Financial Accounting Standards Board released new lease accounting standards. IFRS 16, the international standard, will classify all leases longer than 12 months and greater than $5000 in value as finance leases. ASC 842, the US standard, keeps the classification of finance leases substantially similar to capital leases under ASC 840.

Classification Criteria

IAS 17

Finance leases must meet the following criteria under IAS 17:

  • The underlying asset transfers ownership to the lessee at the end of term
  • There is an option to purchase the underlying asset that is likely to be exercised
  • The lease term is for the major part of the remaining economic life of the asset
  • The present value of lease payments is greater than or equal to substantially all of the fair value of the asset
  • The asset is specialized to the extent that it is only useful to the lessee

IFRS 16

Any lease that is longer than 12 months in length with a value greater than $5000 is a finance lease.

ASC 840

Capital leases must meet the following criteria under ASC 840:

  • The underlying asset transfers ownership to the lessee at the end of term
  • There is an option to purchase the underlying asset that is likely to be exercised
  • The lease term is for at least 75% of the remaining economic life of the asset
  • The present value of lease payments plus any guaranteed residual value is at least 90% of the fair market value of the asset

ASC 842

Finance leases must meet the following criteria under ASC 842:

  • The underlying asset transfers ownership to the lessee at the end of term
  • There is an option to purchase the underlying asset that is likely to be exercised
  • The lease term is for the major part of the remaining economic life of the asset
  • The present value of lease payments plus any guaranteed residual value is greater than or equal to substantially all of the fair market value of the asset
  • The asset is specialized to the extent that it is only useful to the lessee