Lease Accounting Glossary
Glossary of common lease accounting terms
Accounting Standards Codification (ASC) Topic 842 replaced FASB’s previous lease accounting guidance, ASC Topic 840. Public business entities reporting under U.S. GAAP were required to transition to ASC 842 for financial statements for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. Other business entities reporting under U.S. GAAP must apply ASC 842 for annual financial statements for fiscal years beginning after December 15, 2021, and interim periods within fiscal years beginning after December 15, 2022.
The major change resulting from the new standard is that operating leases of lessees, previously only disclosed in the notes to financial statements, are now reported as right-of-use assets and lease liabilities on-balance sheet. The change requires companies to commit to a higher level of data tracking for their operating leases.
Accounting for leases at the asset level is required by ASC 842 and IFRS 16. FASB and IASB (IFRS 16) require asset-level lease accounting to better track companies’ lease portfolios. Asset-level lease accounting is the process of recording transactions by generating debits and credits for each asset on a lease, rather than for the lease as a whole.
Many events that affect lease accounting can occur at the asset level. For example, any change to the assumptions or estimates that affect the present value of a right-of-use asset, including the asset term from a partial buyout, return, or renewal, residual values, impact the accounting. Leases that cover multiple assets may be difficult or impossible to account for at the lease contract level because of differences in the terms relating to individual assets (dates, options, etc.).
An obligation associated with retiring a tangible long-term asset. Lessees can have AROs related to removing their leasehold improvements from the leased property at the end of the lease. AROs can also arise from legal obligations to remove items from the property at the end of the lease or to clean up hazardous materials. Leased plant or equipment might require restoration or refurbishment to return it to a condition in which it is usable by a third party. US GAAP and IFRS have specific guidance on how to account for different types of ARO and such requirements are not the same between for the two.
(glossary term superseded by ASU No. 2016-02)
“A provision allowing the lessee, at his option, to purchase the leased property for a price that is sufficiently lower than the expected fair value of the property at the date the option becomes exercisable that exercise of the option appears, at lease inception, to be reasonably assured.” 1
(glossary term superseded by ASU No. 2016-02)
From the lessee’s perspective, a lease that meets any one of the four lease classification criteria in ASC 840-10-25-1: “(a) The lease transfers ownership of the property to the lessee by the end of the lease term. (b) The lease contains a bargain purchase option. (c) The lease term is equal to 75 percent or more of the estimated economic life of the leased property…. (d) The present value at the beginning of the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs…, equals or exceeds 90 percent of the excess of the fair value of the leased property to the lessor at lease inception over any related investment tax credit retained by the lessor and expected to be realized by the lessor.” 2 Criteria (c) and (d) are not used if the asset is in the last 25% of its total estimated economic life at lease inception.
A capital lease is a lease that “transfers substantially all of the benefits and risks incident to the ownership of property” 3 [and therefore] should be accounted for as the acquisition of an asset and the incurrence of an obligation by the lessee.
The effective or imputed interest rate applied to discount the payment obligations on a finance lease.
Under ASC 840, leases were classified as either capital or operating leases. Capital leases were reported on the balance sheet, and operating leases were reported in the notes to financial statements. Under ASC 842, the classification criteria haven’t changed significantly, but capital leases are now called finance leases. However, all leases over 12 months in length now have to be reported on the balance sheet, regardless of how they are classified. On the IFRS side, under IAS 17 the classification was similar to ASC 840 except that the capital leases were called finance leases. Under IFRS 16, all leases other than short-term and low-value leases need to be capitalized as finance leases.
These are charges by landlords to tenants for their share of the expenses related to the landlord’s managing common areas of leased properties (e.g., maintenance, repairs, landscaping, snow removal). They are considered non–lease components of the lease contract under ASC 842 because they are charges for services other than the right to use the underlying asset. There is a practical expedient available not to separate non–lease components like CAM from related lease components.
Under ASC 840, CAMs were included in executory costs that were expensed as incurred.
(Glossary term superseded by ASU No. 2016-02)
“The increases or decreases in lease payments that result from changes occurring after lease inception based on occurrences events or milestones (other than the passage of time) on which lease payments are based…” 5
Lease payments that depend on a factor directly related to the future use of the leased property, such as machine hours or sales volume during the lease term, are contingent rentals and are excluded from minimum lease payments in their entirety. Lease payments that depend on an existing index or rate, such as the consumer price index or the prime interest rate, are included in minimum lease payments based on the index or rate existing at the inception of the lease; any increases or decreases in lease payments that result from subsequent changes in the index or rate are contingent rentals.
The difference between the amount of cash rental payments and amounts recognized as rent expense in the financial statements creates a deferred liability (if cash rent is less than expense) or a deferred asset (if cash rent is greater than expense). Deferred rent accounting applies to free rent/a rent holiday, or changes in rent amounts over the lease term (such as escalating rent payments). ASC 840 and ASC 842 both require rent expense to be recognized on a straight-line basis over the lease term. The difference was recorded as either a debit or credit to deferred rent under ASC 840. Under ASC 842 the deferred rent is bundled with the righ-of-use asset.
The rate implicit in the lease that equates the present value of the lease payments with the cost basis of the underlying physical asset at lease commencement. for both lessors and lessees. For lessees, if that rate cannot be readily determined (most cases), the lessee should use its incremental borrowing rate. Private companies that find it hard to determine their IBR may elect to use the risk-free rate of return instead.
Footnotes
Note: Most FASB.org links require login to access – free Basic View is accessible by agreeing to terms and conditions
1 10 11 12 ASC 842-20-20 Glossary. https://asc.fasb.org/1943274/2147479390
2 24 25 ASC 840-10-25. https://asc.fasb.org/1943274/2147481155/840-10-25
3 Lee, Susan S. K. “Capital and Operating Leases: A Research Report”. https://files.fasab.gov/pdffiles/combinedleasev4.pdf
4 7 8 9 13 14 15 16 17 18 19 20 21 26 27 29 30 31 32 34 35 36 ASC 842-10-20 Glossary. https://asc.fasb.org/1943274/2147479978
5 22 23 28 33 ASC 840-10-20 Glossary. https://asc.fasb.org/1943274/2147481185
6 FASB Technical Bulletin 85-3. https://www.fasb.org/document/blob?fileName=aop_FTB85-3.pdf
Glossary of common lease accounting terms
Cancellation or termination of the lease agreement before the end of the lease term. The right-of use asset and lease liability are removed from the books, with the difference recognized as a termination gain or loss on the income statement.
Refers to contracts that provide customers the right to control identified assets that are embedded within service contracts, outsourcing agreements, or other arrangements, but may not be explicitly called leases. Embedded leases are subject to accounting under ASC 842. For example, the energy industry often uses pipelines to transfer oil as part of a transportation agreement. If the pipeline is considered an asset under the new lease standard, then that agreement would contain an embedded lease.
Under ASC 842: “Either the period over which an asset is expected to be economically usable by one or more users or the number of production or similar units expected to be obtained from the asset by one or more users.” 8
Leasing contracts often provide options to be exercised during the middle or the end of the lease term. Those options can include full or partial returns, renewals, or buyouts for equipment assets, and expansions, contractions, or renewals for real estate assets.
Ongoing costs under a lease agreement, such as insurance, maintenance, and taxes, whether paid by the lessor or lessee. The treatment of executory costs changed between ASC 840 and ASC 842. Under ASC 840, executory costs were included in minimum lease payments. Under ASC 842, executory costs need to be evaluated to determine whether they are a lease component or a non-lease component, and whether they are included or excluded from the lease payments for accounting purposes.
Under ASC 842: Lessees classify leases as finance leases if they meet one or more of the criteria in ASC 842-10-25-2 at the commencement of the lease. In principle, a lease is a finance lease if it is reasonably certain that the lessee would consume substantially all of the economic benefit from the underlying asset or take title to the asset at the end of the lease term.
Under IFRS 16: Lessees account for all leases over 12 months in length and greater than $5,000 in value as finance leases. For lessors, a finance lease transfers substantially all the risks and rewards of ownership to the lessee, and an operating lease does not.
The chief accounting rule-making body in the United States; a part of the Financial Accounting Foundation (along with the Governmental Accounting Standards Board, which determines accounting rules for governmental bodies).
The chief accounting rule-making body for United States state and local governmental entities; a part of the Financial Accounting Foundation (along with the Financial Accounting Standards Board). Entities subject to GASB rules include public benefit corporations and authorities, public employee retirement systems, and governmental utilities, hospitals, colleges, and universities, as well as states and political subdivisions.
Lease accounting standard for governmental organizations, which supersedes GASB 13 and GASB 62. It provides a single accounting model requiring classification of agreements meeting the definition of “leases” as finance leases and eliminating the distinction between operating and capital leases. GASB 87 is effective for fiscal years beginning after June 15, 2021.
Accounting standard for subscription-based information technology agreements (SBITAs), contracts that convey control of the right to use another party’s software alone or with underlying tangible capital assets. GASB 96 is effective for fiscal years beginning after June 15, 2022.
The entire rent payment due for each payment period, including executory costs but excluding contingent rentals.
Any guarantee by the lessee or any party related to the lessee of the residual value of a leased asset at the expiration of the lease term. The lessee is obliged to make good any shortfall between the guaranteed residual and the actual value realized by the lessor.. When a lessee provides a residual value guarantee, it includes the amount expected to be paid in its lease payments when calculating the lease liability.
Footnotes
Note: Most FASB.org links require login to access – free Basic View is accessible by agreeing to terms and conditions
1 10 11 12 ASC 842-20-20 Glossary. https://asc.fasb.org/1943274/2147479390
2 24 25 ASC 840-10-25. https://asc.fasb.org/1943274/2147481155/840-10-25
3 Lee, Susan S. K. “Capital and Operating Leases: A Research Report”. https://files.fasab.gov/pdffiles/combinedleasev4.pdf
4 7 8 9 13 14 15 16 17 18 19 20 21 26 27 29 30 31 32 34 35 36 ASC 842-10-20 Glossary. https://asc.fasb.org/1943274/2147479978
5 22 23 28 33 ASC 840-10-20 Glossary. https://asc.fasb.org/1943274/2147481185
6 FASB Technical Bulletin 85-3. https://www.fasb.org/document/blob?fileName=aop_FTB85-3.pdf
Glossary of common lease accounting terms
IFRS 16 replaces IASB’s previous lease accounting guidance, IAS 17. Companies reporting under IFRS were required to transition to IFRS 16 starting in January 2019.
An impairment loss occurs when the expected cash flows to be generated from an asset over its useful life are less than the carrying value of the asset. Impairments apply to leased assets under ASC 842 and IFRS 16. Right-of-use assets for leases are required to be tested for impairment periodically or on the occurrence of an event that could potentially trigger a fall in value.
The interest rate the lessor is charging the lessee, which is usually not be specified in the lease agreement. The discount rate directly impacts the lease liability and classification of the lease for the lessor.
Under ASC 842: The rate implicit in the lease is the interest rate that, at a given date, causes the aggregate present value of the lease payments and the amount the lessor expects to derive from the underlying asset after the end of the lease term to equal the sum of the fair value of the underlying asset (less related investment tax credits realizable) and the lessor’s deferred initial direct costs.
Under ASC 840: The discount rate that, when applied to (a) the minimum lease payments, excluding that portion of the payments representing executory costs to be paid by the lessor, together with any profit thereon, and (b) the unguaranteed residual value accruing to the benefit of the lessor causes the aggregate present value at the beginning of the lease term to be equal to the fair value of the leased property to the lessor at the inception of the lease. This is usually not known by the lessee since the unguaranteed residual value is usually not stated.
Under ASC 842: “The rate of interest that a lessee would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment.” 10
Under ASC 840: “The rate that, at lease inception, the lessee would have incurred to borrow over a similar term the funds necessary to purchase the leased asset.” 11
“Incremental costs of a lease that would not have been incurred if the lease had not been obtained.” 12
Under ASC 842: Initial direct costs are included in the calculation of the right-of-use asset. Only external costs, not internal expenses, are considered initial direct costs.
Under ASC 840: Lessees capitalize initial direct costs for both operating and capital leases and amortize them over the lease term. ASC 840 includes both internal and external expenses in the definition.
IASB is the body responsible for setting accounting regulations for Europe and numerous other countries around the world.
Footnotes
Note: Most FASB.org links require login to access – free Basic View is accessible by agreeing to terms and conditions
1 10 11 12 ASC 842-20-20 Glossary. https://asc.fasb.org/1943274/2147479390
2 24 25 ASC 840-10-25. https://asc.fasb.org/1943274/2147481155/840-10-25
3 Lee, Susan S. K. “Capital and Operating Leases: A Research Report”. https://files.fasab.gov/pdffiles/combinedleasev4.pdf
4 7 8 9 13 14 15 16 17 18 19 20 21 26 27 29 30 31 32 34 35 36 ASC 842-10-20 Glossary. https://asc.fasb.org/1943274/2147479978
5 22 23 28 33 ASC 840-10-20 Glossary. https://asc.fasb.org/1943274/2147481185
6 FASB Technical Bulletin 85-3. https://www.fasb.org/document/blob?fileName=aop_FTB85-3.pdf
Glossary of common lease accounting terms
Under ASC 842: A lease is “a contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (an identified asset) for a period of time in exchange for consideration.” 13
Under ASC 840: A lease is “an agreement conveying the right to use property, plant, or equipment (land and/or depreciable assets) usually for a stated period of time.” 14
Subledgers contain detailed transactions from certain accounts that track leasing activity, which can later be consolidated and loaded into a general ledger. Subledgers are frequently used for accounting processes like accounts receivable and payable, preparing a trial balance, and reconciling general ledger accounts.
Lease accounting subledgers are growing in popularity to track right-of-use assets and lease liabilities at the asset level. The lease accounting subledgers can later be aggregated to the schedule or portfolio level for transfer to the general ledger.
Payments (fixed or variable) in a lease agreement for activities that directly transfer the right to use underlying assets to the lessee. ASC 842 includes conditions to be met for a lease component to be considered a separate component. Lease consideration must be allocated to lease and non-lease components based on their respective standalone observable price.
“A change to the terms and conditions of a contract that results in a change in the scope of or the consideration for a lease (for example, a change to the terms and conditions of the contract that adds or terminates the right to use one or more underlying assets or extends or shortens the contractual lease term).” 15
Under ASC 842: Modifications are either accounted for as a change to the accounting for the existing lease, or as a separate new contract with no change to the existing lease.
Under ASC 840: Tests must be performed to determine whether the revised agreement is treated as a new arrangement over its term or a new lease is created.
Incentives lessors provide to lessees, including amounts paid or payable at or before lease commencement, and reimbursements during the lease for tenant improvements and moving expense reimbursements.
The process of determining whether it is more economically advantageous to lease or to buy an asset.
“An entity that enters into a contract to provide the right to use an underlying asset for a period of time in exchange for consideration.” 19
Under ASC 842: “From the perspective of a lessor, a lease that was classified as a leveraged lease [under ASC 840] and for which the commencement date is before the effective date [of ASC 842].” 20
Under ASC 842, new lease contracts may not be accounted for as leveraged leases, but leveraged lease accounting can continue to be applied to leases that are grandfathered in.
Under ASC 840: “From the perspective of a lessor, a lease that meets all of the conditions in paragraph 840-10-25-43(c).” 21
Under ASC 842: “…the payments that the lessee is obligated to make or can be required to make in connection with the leased property, excluding both of the following: (a) Contingent rentals; (b) Any guarantee by the lessee of the lessor’s debt and the lessee’s obligation to pay (apart from the rental payments) executory costs…in connection with the leased property.” 22
“…minimum lease payments include all of the following: (a) The minimum rental payments called for by the lease over the lease term, (b) Any guarantee of the residual value at the expiration of the lease term, whether or not payment of the guarantee constitutes a purchase of the leased property… , (c) Any payment that the lessee must make or can be required to make upon failure to renew or extend the lease at the expiration of the lease term, whether or not the payment would constitute a purchase of the leased property, (d) Payments made before the beginning of the lease term, and (e) Fees that are paid by the lessee to owners of the special-purpose entity for structuring the lease transaction.” 23
Under ASC 840: “…the payments that the lessee is obligated to make or can be required to make in connection with the leased property.” 24 Contingent rentals shall be excluded from minimum lease payments, along with lessee guarantees of lessor’s debt and lessee obligations to pay executory costs in connection with the leased property.
“…Minimum lease payments include all of the following: (a) The minimum rental payments called for by the lease over the lease term, (b) Any guarantee by the lessee (including a third party related to the lessee) of the residual value at the expiration of the lease term, whether or not payment of the guarantee constitutes a purchase of the leased property, (c) Any payment that the lessee must make or can be required to make upon failure to renew or extend the lease at the expiration of the lease term, whether or not the payment would constitute a purchase of the leased property, (d) Payments made before the beginning of the lease term, and (e) Fees that are paid by the lessee to owners of the special-purpose entity for structuring the lease transaction.” 25
If a capital lease has a rent holiday or a period of very low rents, the rent paid may not be sufficient to pay the interest that accrues on the remaining obligation during that period. In such a case, the obligation increases rather than decreases, as the unpaid interest is added to the obligation balance. This is called negative (principal) amortization. The obligation may become larger than the original obligation but is paid down later in the life of the lease.
Payments in a lease agreement for activities that do not transfer goods or services to the lessee. Examples include reimbursement of lessor costs, costs to initiate the lease contract, common area maintenance, and other administrative services. Lease consideration must be allocated to lease and non-lease components.
Under ASC 842: “From the perspective of a lessee, any lease other than a finance lease. From the perspective of a lessor, any lease other than a sales-type lease or a direct financing lease.” 27
Under ASC 840: “From the perspective of a lessee, any lease other than a capital lease. From the perspective of a lessor, a lease that meets the conditions in paragraph 840-10-25-43(d).” 28
Under IFRS 16: Lessees account for all leases over 12 months in length and greater than $5,000 in value as finance leases; for lessors, a finance lease transfers substantially all the risks and rewards of ownership to the lessee, and an operating lease does not.
The frequency with which rental payments are made. Most leases are paid monthly, but some are paid quarterly, semiannually, annually, or more unusual period lengths. Most leases are paid in advance, but some (most often real estate leases) are paid in arrears.
A practical expedient that permits a company to account for a portfolio of leases with similar characteristics together at a combined level if the outcome would not be materially different from accounting for each individual lease. Estimates like lease terms and discount rates are determined for the portfolio overall.
Footnotes
Note: Most FASB.org links require login to access – free Basic View is accessible by agreeing to terms and conditions
1 10 11 12 ASC 842-20-20 Glossary. https://asc.fasb.org/1943274/2147479390
2 24 25 ASC 840-10-25. https://asc.fasb.org/1943274/2147481155/840-10-25
3 Lee, Susan S. K. “Capital and Operating Leases: A Research Report”. https://files.fasab.gov/pdffiles/combinedleasev4.pdf
4 7 8 9 13 14 15 16 17 18 19 20 21 26 27 29 30 31 32 34 35 36 ASC 842-10-20 Glossary. https://asc.fasb.org/1943274/2147479978
5 22 23 28 33 ASC 840-10-20 Glossary. https://asc.fasb.org/1943274/2147481185
6 FASB Technical Bulletin 85-3. https://www.fasb.org/document/blob?fileName=aop_FTB85-3.pdf
Glossary of common lease accounting terms
Lease right-of-use assets and liabilities may be remeasured during the lease term when there are changes in lease contracts or other circumstances related to the lease. Both lease modifications and reassessments result in remeasurement.
A period during which no rent is due, sometimes offered at the beginning of a lease as an inducement to enter into the lease agreement. If the rent holiday comes during an optional renewal period, it is considered a “bargain renewal opt-on” and all periods up to and including the holiday are part of the lease term.
A series of equal rental payments made once every payment period.
The rate investors expect to earn from an investment with zero risk, such as a zero-coupon US. Treasury instrument, for the period comparable to the term of the lease. Under ASU 2021-09, there is a practical expedient for non-public business entity lessees to elect an accounting policy to use a risk-free rate by class of underlying asset as the discount rate.
A transaction in which an owned asset is sold to a financing company, which then immediately leases the asset (usually real estate) back to the seller. This enables the seller to receive cash immediately for the asset and often remove it from the books. There are specific accounting requirements in both ASC 842 and ASC 840 related to sale/leaseback transactions.
Under ASC 842: “A transaction in which an underlying asset is re-leased by the lessee (or intermediate lessor) to a third party (the sublessee), and the original (or head) lease between the lessor and lessee remains in effect.” 32
Under ASC 840: “A transaction in which a leased property is re-leased by the original lessee to a third party, and the lease agreement between the two original parties remains in effect.” 33
The existence of a sublease means that three different parties are involved: the original lessor, who owns the asset and receives rent; the lessee/sublessor, who pays the lessor rent and receives rent from the sublessee; and the sublessee, who uses the asset and pays rent. A sublease may be for just a portion of the asset originally leased.
The difference between the asset and the obligation at the time a capital lease is terminated. If the net asset at date of termination is greater than the remaining obligation, the difference is recorded as a loss; if the obligation is greater (which is the normal case when a lease is early terminated), the difference is recorded as a gain. The gain or loss may be offset by a cancellation penalty or, if the asset is purchased, by setting it up as an owned asset.
A property lease agreement where the lessee pays all the property expenses, including maintenance, insurance, and real estate taxes, in addition to rent and utilities. They are typical for commercial real estate.
Footnotes
Note: Most FASB.org links require login to access – free Basic View is accessible by agreeing to terms and conditions
1 10 11 12 ASC 842-20-20 Glossary. https://asc.fasb.org/1943274/2147479390
2 24 25 ASC 840-10-25. https://asc.fasb.org/1943274/2147481155/840-10-25
3 Lee, Susan S. K. “Capital and Operating Leases: A Research Report”. https://files.fasab.gov/pdffiles/combinedleasev4.pdf
4 7 8 9 13 14 15 16 17 18 19 20 21 26 27 29 30 31 32 34 35 36 ASC 842-10-20 Glossary. https://asc.fasb.org/1943274/2147479978
5 22 23 28 33 ASC 840-10-20 Glossary. https://asc.fasb.org/1943274/2147481185
6 FASB Technical Bulletin 85-3. https://www.fasb.org/document/blob?fileName=aop_FTB85-3.pdf
Glossary of common lease accounting terms
“An asset that is the subject of a lease for which a right to use that asset has been conveyed to a lessee. The underlying asset could be a physically distinct portion of a single asset.” 34
Under ASC 842: “The amount that a lessor expects to derive from the underlying asset following the end of the lease term that is not guaranteed by the lessee or any other third party unrelated to the lessor, measured on a discounted basis.” 35
Under ASC 840: The estimated residual value of the leased property exclusive of any portion guaranteed by the lessee or any unrelated third party. This is used to determine the implicit interest rate but is typically not known by the lessee. If the unguaranteed residual value is not known, the implicit rate is not used in lessee accounting for the lease.Under ASC 840: The estimated residual value of the leased property exclusive of any portion guaranteed by the lessee or any unrelated third party. This is used to determine the implicit interest rate but is typically not known by the lessee. If the unguaranteed residual value is not known, the implicit rate is not used in lessee accounting for the lease.
“Payments made by a lessee to a lessor for the right to use an underlying asset that vary because of changes in facts or circumstances occurring after the commencement date, other than the passage of time.” 36
Footnotes
Note: Most FASB.org links require login to access – free Basic View is accessible by agreeing to terms and conditions
1 10 11 12 ASC 842-20-20 Glossary. https://asc.fasb.org/1943274/2147479390
2 24 25 ASC 840-10-25. https://asc.fasb.org/1943274/2147481155/840-10-25
3 Lee, Susan S. K. “Capital and Operating Leases: A Research Report”. https://files.fasab.gov/pdffiles/combinedleasev4.pdf
4 7 8 9 13 14 15 16 17 18 19 20 21 26 27 29 30 31 32 34 35 36 ASC 842-10-20 Glossary. https://asc.fasb.org/1943274/2147479978
5 22 23 28 33 ASC 840-10-20 Glossary. https://asc.fasb.org/1943274/2147481185
6 FASB Technical Bulletin 85-3. https://www.fasb.org/document/blob?fileName=aop_FTB85-3.pdf
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