FAS 13 / IAS 17 Operating lease example

Let’s take as an example an office lease, for a portion of an office building. It lasts for ten years. The first 5 years, the rent is $5,000 per month; the second five years, the rent increases to $6,000 per month.

In many cases, the “fair value” of a portion of a building is not easily determinable. If this is true, FAS 13 allows you to skip the present value test [FAS 13, para. 28]. Such leases will, as a rule, never convey ownership, so the only test left to determine whether the lease is capital is whether the lease term is 75% or more of the economic life. A building is typically assigned a life of 20 years or more, so this lease’s 10-year term is considerably less than 75%, and the lease is considered operating.

FAS 13/IAS 17 - Operating lease example: Office lease

If there were no change in the rents, the rental payments would simply be expensed as incurred, making very simple accounting (though the future rent commitment of all leases needs to be disclosed). Since this lease has a scheduled rent increase, which does not reflect a change in the availability of the asset (for example, an increase in the space covered by the lease), FASB Technical Bulletin 85-3 (FTB 85-3) requires the rent to be recognized on a straight-line basis over the life of the lease, with a deferred liability that accounts for the difference between cash rent paid and accrued rent expense. (A lessor also straight-lines the rent, recognizing a deferred asset.)

Debit Credit
Monthly journal entry (first 5 years)
Operating rent expense
5,500.00
Deferred liability
500.00
Cash
5,000.00
Monthly journal entry (second 5 years)
Operating rent expense
5,500.00
Deferred liability
500.00
Cash
6,000.00

Note: At the end of the life of the lease, the deferred liability will be zero. If a lease is terminated early, you recognize a gain equal to the balance in the deferred liability account (because rent that you have expensed will not actually need to be paid). Any termination penalty is an offsetting loss.

Pink checkmark icon | EZLease

Easy testing.

Load this example into EZLease from our bulk import template.

You also need to disclose your future rent commitments. At the end of the first year, for example, you have four years of $5000 per month rent remaining, plus five years of $6000 per month. (Future rent commitment disclosure is based on cash, not accrual, rent)

As of December 31, 2010, your disclosures will be displayed as in the following schedule by years of minimum future rentals on a noncancellable lease operating

Account
Year ending December 31, 2010
2011:
60,000
2012:
60,000
2013:
60,000
2014:
60,000
2015:
72,000
Later years:
288,000
Total minimum future payments required:
600,000

To enter this lease in EZLease, follow these steps* :

* System settings are 6/30 Year End with a GASB 87 Implementation date of 7/1/2022.

FAS 13 / IAS 17 Operating lease example

See other easy lease accounting tutorials

Read. Learn. Test for free.

Capital/Finance leases

Capital/Finance leases

Capital/Finance leases

Operating leases