Do you report under GAAP or IFRS? If so, you are most likely large enough to have both equipment and real estate leases in your portfolio. After speaking with hundreds of companies, we discovered that historically these have been tracked in different departments. Both real estate and equipment operating leases are currently reported as off-balance sheet transactions. The exception to this is capital leases. (Here is a free accounting tool for capital lease vs operating lease).
Typically, the Real Estate department handles the signing and tracking of real estate leases. The information is then sent to the Accounting department each reporting period. Equipment leases are signed and tracked by multiple departments, ranging from fleet and facilities management to IT, who also send information to the Accounting department at each reporting period. Since this process is not under a single department, it is not uncommon for several leases to get lost in the translation to the accounting department. The real estate leases are typically more material because of the higher lease obligation so, the equipment leases end up being missed most often (Use this free lease accounting transition guide to identify more departments to find missing leases).
Most leasing software on the market started as lease management or administration software and was built for real estate professionals. Because all operating leases were previously off-balance sheet transactions, the accounting functionality was not a high priority. The people who developed these software packages have real estate backgrounds because that was the most important knowledge to have in building the solutions at the time. That all changed in January and February of 2016 when both the FASB and IASB released significant changes to the lease accounting standard (read more about the lease accounting changes here).
We have put together this quick list of questions to ask any potential lease accounting software vendor so you can make an informed decision and understand if they are the best choice to handle both your real estate and equipment leases.
Or, if you’d like to see what lease accounting software can do for you, click here.
In today’s blog post, we will discuss and explain capital lease accounting. We will utilize a detailed example to illustrate the accounting entries involved, but let us stress that this example covers capital lease accounting under CURRENT accounting rules by the FASB and IASB –Topic 840/FAS 13 and IAS 17 respectively. In a subsequent blog post, we will address “Finance” lease accounting under the NEW Lease Accounting Standards issued by the FASB and IASB—Topic 842 and IFRS 16, respectively (under Topic 842, capital leases will be called finance leases).
As a refresher, a capital lease is one in which a lessee records the leased asset as if it purchased the asset using funding provided by the lessor. As a result, capital lease accounting under current GAAP is actually comprised of two transactions: A purchase of the underlying asset by the lessee AND a loan to the lessee from the lessor to fund the purchase of said asset.
A lessee should record a lease as a capital lease and therefore apply capital lease accounting if ANY of the following criteria are met:
- First Criterion: Ownership of the underlying asset transfers to the lessee after the lease term; or
- Second Criterion: There is a “bargain purchase option”, meaning that the lessee has an option to buy the underlying asset after the lease term at a price that’s below-market; or
- Third Criterion: The lease term is 75% or greater than the useful life of the underlying asset; or
- Fourth Criterion: The present value of the minimum lease payments is at least 90% of the fair value of the asset.
This article was contributed by LeaseQuery: LeaseQuery is lease management software that helps companies manage their leases. Rather than relying on excel spreadsheets, our clients use LeaseQuery to get alerts for critical dates (renewals, etc), calculate the straight-line amortization of rent and TI allowances per GAAP, provide the required monthly journal entries (for both capital and operating leases) and provide the commitment disclosure reports required in the notes and the MD&A. Contact here.