Understanding Finance and Operating Lease Under the New Standards

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Under new lease accounting standards, capital leases are renamed as financial leases. While this might be a small change in the name, there are other significant changes required related to balance sheets.

As per the new standards, operating leases need to be added to the financial statements. If you are yet unfamiliar with the new standards, it may potentially lead to unsuccessful compliance. This blog aims to equip you with all the necessary information, which in turn, will help account for leases in the balance sheet correctly.

Under ASC 842

As per the new lease accounting standards, ASC 842, operating and finance remain the two types of leases that must be accounted for in a company’s balance sheet. It is important to note here that before ASC 842, only capital, or finance, leases as they are now called, were recorded. Also, as per the ASC 840 standards, operating leases were not included in the balance sheet. They were considered transactions conducted outside the balance sheet. The new standards aim to provide better transparency of the lessee’s obligations to investors.

Also, there are several criteria based on which a lease is classified as a financial lease. It includes the transfer of title or ownership to the lessee, which occurs after a lease term has ended. Additionally, purchase option, the economic life of an asset, determining present and future value of the asset, fair value of the asset, among others, are the other criteria.

Another new criterion with ASC 842 is asset specialization. It asks the lessee to understand and consider if the asset has such characteristics that it provides no other use to the lessor after the lease term. As mentioned before, a lease must meet one of the criteria to be recognized as a finance lease. But it has been found that if a lease passes this test of asset specialization it automatically triggers one of the other four criteria.

Under IFRS 16

Under the lease accounting standards of IFRS 16, there is only one classification of leases known as a financial lease. It must be recognized in the balance sheet and classified on the financial statement. As per IFRS 16, leases now follow a single model approach. Thus, the questions regarding classification have shifted. The focus is now on lease agreement definitions and whether they are met. Also, the corresponding asset and lease liability must be recorded.

Under GASB 87

Under GASB 87, a single classification model is followed where all leases are recognized as financial leases. The Basis of Conclusion for GASB 87 clearly states the reason behind such classification, which is: “statement is based on the foundational principle that leases are financings.” Thus, every lease under GASB 87 that has a right-of-use (ROU) asset and a lease liability that corresponds to it is recorded.

As you can see, there are few differences regarding finance and operating leases under new lease accounting standards. The implementation of the same also demands various new accounting treatments and approaches. Using a lease accounting software will help companies ease the implementation process. Yardi Corom is an easy to use, 100% cloud-based lease accounting solution for managing your corporate leases and deals. For more details, book a demo today and explore the benefits of Corom Lease Management.