This comprehensive guide is designed to help you understand the basics of lease accounting, the latest lease accounting standards, and leasing pros and cons.
Lease accounting is a complex area of accounting that requires an understanding of Generally Accepted Accounting Principles (GAAP). Lease accounting is the process of accounting for leases in accordance with GAAP. Under GAAP, leases are classified as either finance leases or operating leases.
In accounting and finance, leasing is a common way for businesses to acquire assets without having to buy them outright. There are two types of leases: finance leases and operating leases. The primary difference between the two is how they are accounted for on a company's financial statements.
Finance leases are long-term leases of expensive assets, where the lessee takes on most ownership risks and rewards. Lessees record the asset on their balance sheet and are responsible for maintenance, insurance, and other costs.
Finance leases are typically used for assets like buildings, machinery, or vehicles.
Operating leases, on the other hand, are short-term leases of assets with high turnover rates, where lessors retain most ownership risks and rewards. With operating leases, lessees don't record the asset on their balance sheet, but rather record lease payments as rental expenses on their income statement. Lessors are responsible for maintenance, insurance, and other costs. Operating leases are typically used for assets like office equipment or vehicles.
The choice between finance and operating leases depends on a company's accounting and tax requirements, as well as its cash flow and operational needs.
The international standard for lease accounting is IFRS 16, issued by the International Accounting Standards Board (IASB). This standard applies to all companies that report under International Financial Reporting Standards (IFRS), which are used in many countries around the world.
In the United States, the Financial Accounting Standards Board (FASB) issued a new standard for lease accounting called ASC 842, which became effective for public companies in 2019 and for private companies in 2022. ASC 842 is similar in many ways to IFRS 16, but there are some differences in the details of the standards.
Other countries may have their own local accounting standards for lease accounting, which may differ from IFRS or ASC 842. However, many countries are moving towards adopting international standards like IFRS 16 to promote consistency and comparability in financial reporting.
Lease accounting can impact a company’s financial statements. With the implementation of the new lease accounting standard, ASC 842, operating leases must now be recorded on the balance sheet. This means that businesses with operating leases will see an increase in their total assets and liabilities, which can affect their debt-to-equity ratio, as well as other financial ratios.
To comply with ASC 842, businesses must carefully review their lease agreements and assess the impact of the new standard on their financial statements.
The latest lease standard will provide several benefits to companies, investors, and stakeholders. By recognising lease obligations on the balance sheet, the new standard will provide investors with a more accurate and complete picture of a company's financial health.
The new standard will also provide companies with greater visibility into their lease obligations, which may help them make more informed business decisions. It will also promote consistency and transparency in financial reporting across different industries and countries.
To prepare for the new lease standards, companies should begin by:
Companies should also consider implementing new lease accounting software and making changes to their accounting policies and internal controls.
It is also important for companies to communicate the impact that the new standards will have on their stakeholders, including investors, lenders, and customers. By proactively addressing the new standard, companies can minimise disruptions to their business operations and financial reporting processes.
When evaluating lease accounting software, there are several important considerations to keep in mind. Here are some key factors to consider when looking for a software solution to manage lease accounting:
For more information about lease accounting software benefits, capabilities, and applications, click here.
