[3] A lease is a contract calling for the lessee (user) to pay the lessor (owner) for use of an asset for a specified period of time.
[5] As there are many ways to view how these contracts affect the balance sheets of both the lessee and lessor, FASB created a standard for US accountants and businesses.
An operating lease records no asset or liability on the financial statements, the amount paid is expensed as incurred.
The basic criteria for capitalization of a lease by lessee are as follows: These are called the 7(a)-7(d) tests, named for the paragraphs of FAS 13 in which they are found.
Conversely, if none of the criteria are met, the contract is an operating lease, and the lessee will have a footnote in its balance sheet to that effect.
Other lessee financial accounting issues: Under an operating lease, the lessor records rent revenue (credit) and a corresponding debit to either cash/rent receivable.
Under a capital lease, the lessor credits owned assets and debits a lease receivable account for the present value of the rents (an asset, which is broken out between current and long-term, the latter being the present value of rents due more than 12 months in the future).
[9] The project goal, “to insure that investors and other users of financial statements are provided useful, transparent, and complete information about leasing transactions in the financial statements”, reflected investor and regulator concerns that current accounting standards fail to clearly portray the resources and obligations from leases in a complete and transparent manner.
[10] The goal of these changes was to increase transparency within the rules and eliminate a loophole that allows for off-balance-sheet financing through leases.
As originally released, ASC 842 required companies to restate comparable years in their annual reports.
Most U.S. companies include two years of comparables in their annual report, so leases would, in 2019, be restated using the new standard effective 2017.
The FASB decided to maintain the traditional distinction between capital (finance) and operating leases (and reverted to that terminology rather than "Type A/B").
The concept of "executory costs," which were excluded from capitalization under FAS 13, has been replaced by "nonlease components," which are payments due as part of a lease agreement which reflect goods or services separate from the asset.
Importantly, passthrough costs paid by the lessor and rebilled to the lessee, such as taxes and insurance, no longer qualify to be excluded from capitalization (either for finance or for operating leases).
To the asset is added any initial direct costs and subtracted any lease incentives (such as a tenant improvement allowance).
Sale-leaseback accounting is no longer permitted if the seller-lessee has a continuing right of control, such as an option to purchase back the asset at a fixed price.
The U.S. Securities and Exchange Commission (SEC) in 2005 estimated that companies had approximately $1.25 trillion of operating lease commitments.