A major change brought about by the new lease accounting standards is the new obligation of lessees. Not only is it the lessor’s responsibility to maintain accurate lease-accounting records, but it is also the responsibility of the lessee.
- The new lease accounting standards require both lessees and lessors to record leases on the balance sheet
- NetLease and NetLessor are software solutions that automate and simplify the new bookkeeping responsibilities of lessees and lessors
- Lessors are the party that provides an asset to a lessee, while the lessee makes payments to the lessor for a specified period according to the lease contract
- What is a lessor vs. a lessee?
- A lessor is the party that provides an asset, like a vehicle or building.
- A lessee is the party that receives the asset and makes payments to the lessor over a specified period.
Example: Leasing a truck
The lessor and lessee enter into a lease agreement where the lessor provides the truck to the lessee
In return, the lessee makes payments to the lessor for the length of time established in the lease contract.
New bookkeeping responsibilities for lessees
Lessees must now record leases on the balance sheet. Under the old standard, capital leases were recorded on the balance sheet while operating leases were not. Now, operating and financing leases will have a lease liability and a right of use (ROU) asset on the balance sheet. This change to record leases on the balance sheet is intended to help create a better picture of a company’s liabilities.
Learn more about how to successfully transition to the new lease accounting standard.
New bookkeeping responsibilities for lessors
Depending on which new standard you are on (ASC 842, IFRS 16, or GASB 87), there have been some accounting changes on the lessor side. For ASC 842, there hasn’t been as major a change, but one important item to note is the lease classifications. While the classifications haven’t changed (operating, sales-type and direct financing), the requirements for sales-type and direct financing have changed.
Lessor or lessee: software saves time
Although spreadsheets are great for most tasks, they aren’t best for everything. How many times have you had to search for the most up-to-date Excel file because other people created duplicate copies to perform their tasks? How many times have you seen a number or formula that has been inputted incorrectly, drastically changing the result?
With software, a lot of the small errors that can have massive impacts can be eliminated, which is especially important given the demands of the new lease accounting standards.
NetLease is the accounting solution for lessees. You need to include lease accounting in your books if you lease or rent:
- Office space
- Dedicated production lines
NetLease is a software solution that automates and simplifies the new bookkeeping responsibilities of lessees regardless of ERP. Cut out the confusion and skip to the solution.
NetLessor is our lessor-side accounting solution. As an embedded SuiteApp, no third-party integration is required with NetSuite. However, you must have NetSuite to use it. If you are on NetSuite, NetLessor builds on your existing financial information and automation.
Simply put, the lessor is the party that provides an asset to a lessee. In return, the lessee makes payments to the lessor for a specified period according to the lease contract. Both have bookkeeping obligations under ASC 842 that can easily be automated with Netgain software solutions.
What do the new lease accounting standards require?
The new lease accounting standards require lessees to record leases on the balance sheet and for lessors to classify leases as operating, sales-type, or direct financing.
Every lease is categorized as either a finance lease or an operational lease under ASC 842, which is similar to ASC 840, the previous lease accounting standard. This is true for all types of leased assets specified by the standard, such as equipment and real estate leases. The phrase "finance lease" has taken the place of the phrase "capital lease" in Topic 840. ASC 842 also modifies what qualifies as a finance or capital lease.
The assets and liabilities resulting from their leases must be recognized by lessees reporting under Topic 842. The lease asset is equivalent to the lease liability adjusted for specific factors like prepaid rent, initial direct expenditures, and lease incentives. The lease liability is calculated as the present value of lease payments.
How does the new lease accounting standard affect lessees?
Under the new lease accounting standard, lessees must record leases on the balance sheet. This includes both operating and financing leases, which will have a lease liability and a right of use (ROU) asset on the balance sheet.
The new standard applies to all businesses that lease assets. Each standard has several characteristics that allow some types of leases to be exempt from capitalization (i.e. short-term leases). Nonetheless, the new standard will need to be applied by all businesses with the authority to use at least one in-scope asset that qualifies as a lease.
The main modification to lease accounting under the new standards is that most lease agreements must now be recorded as assets and liabilities on the balance sheet. To generate a lease liability and the associated ROU asset, lessees must determine the present value of future lease payments.
Does ASC 842 affect lessors?
ASC 842 won't result in any significant, fundamental changes to lessor accounting. Nonetheless, lessors categorize leases into one of three categories:
- Sales-type lease
- Direct financing
- Operating lease
Additionally, for leases with direct financing and sales-type terms, a lessor will still
- Acknowledge their net investment in the lease and exclude the leased asset from the balance sheet and acknowledge their net investment in the lease
- Recognize selling profit and interest income on the income statement. The timing of the recognition will depend on the lease classification
- With sales-type leases, there are two types of income. The interest income is recorded as well as a possible up-charge that the lease is being sold for (ex: sales profits). With direct financing, there is only interest income
Likewise, for operating leases, a lesser will still:
- Acknowledge the underlying leased asset on their balance sheet
- Acknowledge lease income on a straight-line basis over the lease term
What is the difference between the old and new lease accounting standard?
The main difference between the old and new lease accounting standard (ASC 840 and ASC 842) is that the new standard requires lessees to recognize some leases on the balance sheet.
The primary distinction between the old and new lease accounting standards is the requirement to recognize operating leases on the balance sheet. Prior to this new standard, only financing leases were recognized.
Short-term leases – leases with a term of 12 months or less without a purchase option that is “reasonably certain” to be exercised – are not required to be recognized on the balance sheet.
What’s the difference between finance and operating leases
You might be wondering why there is a distinction between finance and operating leases if all leases longer than 12 months must be reflected on the balance sheet. The accounting and reporting practices for finance and operating leases differ somewhat.
The main distinction has to do with how expenses are reported on the income statement. With financing leases, expenses are recorded higher at the beginning of the lease and decline over the duration of the lease. With operating leases, expenses are recorded on a straight-line basis over the life of the lease.
- Lessees should classify a lease as a Finance lease when the lease meets any of the following criteria at lease commencement:
- By the end of the lease period, the underlying asset is transferred into the lessee's possession.
- The lease gives the lessee a purchase option over the underlying asset, which the lessee is likely to exercise.
- The lease term covers the majority of the underlying asset's remaining economic life.
- The fair value of the underlying asset is substantially equal to or exceeded by the present value of the lease payments plus any guaranteed residual value.
- The underlying asset is so specialized that the lessor anticipates having no other use for it at the end of the lease term.
- The lease should be categorized as an operating lease if none of the five aforementioned conditions are met.
For Finance leases, a lessee will:
- Create an asset for right-of-use (ROU) and a liability for leasing it, initially valued at the present value of the lease payments.
- In the income statement, separate out interest on the lease debt from amortization of the ROU asset.
- On the statement of cash flows, include repayments of the lease liability's principal portion under financing activities, repayments of the lease liability's interest, and payments for variable leases under operating activities.