Accounting for leases in the United States is governed by the Financial Accounting Standards Board (FASB) by Financial Accounting Standard Number 13, now known as the Codification Account Standard Topic 840 (ASC 840). These standards were effective from January 1, 1977. The FASB was completed in February 2016 of a revised accounting lease standard, called ASC 842.
Video Accounting for leases in the United States
Introduction
A rent is a contract that asks the lessee to pay the lessor (owner) for the use of the asset for a certain period of time. Rental Agreement is a lease in which an asset is a tangible property. Because there are many ways to see how these contracts affect the balance sheets of both the lessee and the lessor, the FASB creates standards for accountants and US businesses.
Maps Accounting for leases in the United States
Accounting for leasing by FAS 13/ASC 840
The accounting profession recognizes the lease as operating lease or capital lease (finance lease). An operating lease records no assets or liabilities on the financial statements, the amount paid is charged as incurred. On the other hand, capital leases are recorded as both assets and liabilities in the financial statements, generally at the present value of rent payments (but never greater than the fair market value of an asset). To distinguish the two, the Financial Accounting Standards Board (FASB) provides the criteria for when the lease should be capitalized, and if any of the criteria for capitalization are met, the lease is treated as capital lease and recorded on the financial statements. The main standard for lease accounting is Statement of Financial Accounting Standard 13 (FAS 13), which has been amended several times; this is known as the topic 840 in the new FASB Code Codification Standards.
The basic criteria for rental capitalization by the lessee are as follows:
- The lessor transfers the asset to the lessee at the end of the lease term.
- The cheap purchase option is given to the lessee. This is an option that allows the lessee, after termination of the lease, to purchase the leased asset at a price far lower than the expected fair market value of the asset.
- The rental age is equal to or greater than 75% of the economic life of the asset.
- The present value of the minimum lease payments (MLP) equals or greater than 90% of the fair market value of the leased property. To understand and apply these criteria, you need to familiarize yourself with what is included in the minimum lease payments and how the present value is calculated. Minimum lease payments include minimum lease payments less any execution fee, guaranteed residual value, bargaining purchase options, and any penalty for not renewing or extending the lease. The calculated amount is then discounted using the incremental lending rate of the lessee. However, if the lessee knows the implicit level used by the lessor and the tariff is less than the lessee's rate, the lessee must use the lessor's rate to discount the minimum lease payments.
These are called 7 (a) -7 (d) tests, named for paragraph FAS 13 where they are found.
If any of the above are met, the lease will be considered as capital or finance lease and should be disclosed on the lessee's balance sheet. Conversely, if no criteria are met, the contract is an operating lease, and the lessee will have a footnote in the balance sheet for that effect. Both parties (lessors and lessees) should review these criteria at the outset and independently determine the classification because it is possible to classify them differently (it is very common, in fact, for a single lease to be considered a lessor lease by lessors and operating leases by the lessee).
If the lease term does not exceed 12 months, the lease may be deemed not to meet the above criteria. These contracts are "leases" and need not be disclosed in the lessee's footnote.
For an in-depth explanation, see the accounting textbook Intermediate Accounting , ed 11, Kieso Weygandt Warfield.
Accounting Lessee
Under an operating lease, the lessee records the rent (debit) expense during the lease term, and credit in cash or rent. If an operating lease has scheduled changes in the lease, the lease should normally be charged on a straight-line basis over the course of its life, with deferred liabilities or assets reported on the balance sheet for the difference between expenditure and cash disbursements.
Under capital lease, the lessee does not record the rent as a fee. Instead, the lease is reclassified as interest and liability payments, just like a mortgage (with interest calculated per lease period on outstanding outstanding liabilities). At the same time, assets are depreciated. If the lease has a transfer of ownership or a bargaining purchase option, a depreciable life is the economic life of an asset; otherwise, life that can be depreciated is the rental period. During the lease term, the combined interest and depreciation will be equal to the rent payment.
For capital and operating leases, separate footnotes for financial statements reveal future minimum lease commitments, based on years over the next five years, then all remaining years as a group.
Other lessee's financial accounting problems:
- Leasehold Improvements: Improvements made by the lessee. It is permanently affixed to the property, and returns to the lessor upon termination of the lease. The value of lease repairs should be capitalized and depreciated over the lower of the lease life or the life of infrastructure improvements. If the lease repair period extends the life of the initial lease term and becomes an option period, usually the period of the option should be considered part of the lease term. If the lessor provides lessee cash benefits for repairs, this is treated as a rental deduction and amortized over the lease term.
- Bonus Rental: Prepayment for upcoming fees. Classified as assets; are amortized using the straight-line method over the life of the lease.
- Hire Kicker, or Rent Percentage: General at retail store rental. This is a premium rental payment that requires the lessor and is treated as a period fee. For example, it can be stated in the contract that if the sale is more than $ 1,000,000, any excess on this amount will have 2% taken as a lease holder. This is not reported as part of the disclosure of the minimum lease commitments in the future, or in 7 (d) testing to determine whether the lease is capital or operating.
Lessor Accounting
Under an operating lease, the lessor records rental (credit) and debit income related to cash receivables/leases. Assets remain in the lessor's books as assets owned, and the lessor records the cost of depreciation over the lifetime of the asset. If leases change during the lease term, lease income is usually recognized on a straight-line basis (also called rental leveling), and the difference between income and cash receipts is recorded as deferred assets or liabilities (reflection of accounting tenants).
Under a capital lease, the lessor credits the held assets and debits the account of the lease receivable for the present value of the lease (assets, damaged between current and long term, the latter is the present value of the lease for more than 12 months in the future). With each payment, cash is debited, receivables are credited, and unearned income (interest) is credited. If the cost or carrying amount of the leased asset differs from its fair value at the beginning, the difference is recognized as profit and the lease is called a sales lease. This is most often the case when manufacturers use leasing as a method of selling their products. Leases of rent or lease of other capital, where the cost and fair value are the same, are called direct financing leases. The third type of capital lease the lessor, called leveraged lease, is used to recognize the lease on which the acquisition of the leased asset is substantially financed by debt.
Lease on Accounting Lease (ASC 842)
As part of their joint commitment to "development of high quality, compatible accounting standards that can be used for domestic and cross-border financial reporting", the International Accounting Standards Board (IASB) and FASB agreed in 2006 for priorities and milestones for the convergence of lease accounting rules. The purpose of the project, "to ensure that investors and other users of financial statements are provided with useful, transparent and complete information about lease transactions in financial statements" reflects the concerns of investors and regulators that the current accounting standards fail to clearly define the resources and obligations of the lease in a complete and transparent manner. The purpose of this change is to increase transparency in rules and eliminate loopholes that allow off-balance-sheet financing through leases.
The project started in 2006. Important dates in the project include;
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- Publishing Discussion Paper - Hire: Initial View - on March 19, 2009 with the public comment period open until July 17, 2009
- Issuance of Joint Exposure Drafts on August 17, 2010 with public comment period open until December 15, 2010
- Issuance of the second joint Exposure Draft on May 16, 2013, with the public comment period open until 13 September 2013
- Issuance of International Financial Reporting Standards 16 (IFRS 16), Leases, on January 13, 2016
- Issuance of ASC 842, as the Updated Accounting Standard 2016-02, on February 25, 2016
Effective Date of the new standard - the date on which when all companies must comply with new lease accounting standards when preparing financial statements - the fiscal year begins after December 15, 2018. However, companies will be required to declare a comparable birthday in their annual report. Most US companies cover two years of comparisons in their annual reports, so rent should, by 2019, be restated using effective new standards 2017. Private companies may postpone compliance until the end of fiscal year 2020.
Proposed changes
The first Introduction and Exposure Design calls for the abolition of the FAS 13 test which classifies the lease as operating lease or capital lease, and treats all rent equal to the current capital lease. All leases are recorded as assets and liabilities on the balance sheet - on the asset side as "assets of use rights" and on the liabilities side as lease obligations; in the statements of income, depreciation and interest expense will be recognized in lieu of rental costs. One implication of this is that the expenses are "front loaded," because interest costs are higher in the early part of the lease term while the liability is higher. Following substantial protests from the makers and users of the financial statements, the second Draft Exposures returns two types of lease accounting, under "Type A" leases that are treated essentially the same as capital leases 13 FAS and "Type B" leases that maintain a single lease fee, rental age, which characterizes FAS 13 leasing operations, but with assets and liabilities on the balance sheet. Liabilities will be the present value of the remaining lease; the asset will be equal to the obligation for a simple lease, but then adjusted to the schedule changes in the lease (which under FAS 13 resulted in deferred lease liabilities or assets) and amortization of initial direct costs and rental incentives. Effective with the second Exposure Draft, the new standard has been given the topic number of the new Accounting Standards Codification 842 (the topic number for the previous lease of 840).
While the first Planned Exposure Draft including rent is assessed as "more likely than not" to be paid (rent and contingent options for renewal) in addition to the required minimum lease payments, subsequent decisions by the board reversed this plan, making the proposed accounting for the lessee similar to it of the existing capital lease. Accounting Lessor is largely restored to existing standards. Leases with a maximum period of 12 months or less will be treated in accordance with current operating lease rules.
After the second Exposure Draft, the IASB decides to require all leases to be treated as finance leases. The FASB decides to maintain the traditional distinction between capital (finance) and operating lease (and return to that term rather than "Type A/B").
Accounting Lessee
In the final release of ASC 842, capital lease accounting has little change, although it is now called "finance lease," consistent with the IFRS terminology. The concept of "executor fees," issued from capitalization under FAS 13, has been replaced by a "nonlease component," which is a payment due as part of a lease agreement that reflects goods or services separate from assets. Importantly, passthrough fees paid by the lessor and rebilled to the lessee, such as taxes and insurance, no longer qualify to be exempt from capitalization (whether for finance or for operating leases). This can mean a substantial difference in the impact of the balance sheet between gross real estate leases and net lease.
The tests to distinguish finance and operating leases are essentially unchanged, although written using a "consistent terminology" consistent with IFRS: for example, a lease is a finance lease if the lease term covers the "main part" of the asset's economic life. The standard countries in paragraph 842-10-55-2 that "one reasonable approach" is to use the 75% FAS 13 test, paragraph 7 (c) to define the "main part," and another 7th paragraph test for another ASC 842. An additional criterion for the lease financing classification is that "Underlying assets are of special nature and are therefore expected to have no alternative use for the lessor at the end of the lease term." (However, such a lease will usually have sufficient rent to meet the present value test.)
For operating leases, liabilities and assets entitled to use are fixed at the start of the lease, at the present value of the lease plus any remaining guaranteed. For assets added any initial direct costs and reduced rental incentives (such as tenant repairs allowances). Liabilities are amortized using the interest method (such as a mortgage). If the lease has the same lease throughout its lifetime, the net asset at any point equals the liability, plus the unamortized balance of the initial direct costs and rental incentives. If the rental price changes during the lease term, the difference between the average cash lease and lease is added to or subtracted from the asset as well.
Single lease expense is recognized for operating leases, which reflects the combined amortization of assets and liabilities. This is considered an operating expense, similar to the cost of an ASC 840 rental, so there is usually no difference in the income statement or cash flow statement of the company compared to ASC 840.
Leaseback-sale accounting is no longer allowed if the lessee-seller has sustainable control rights, such as the option to repurchase the asset at a fixed price. A failed resale transaction is considered to be financing.
Lessor Accounting
Most lessor accounting has not changed much between ASC 840 and ASC 842. Changes from executory fees to nonlease components, discussed above, apply equally to lessors. Leveraged leasing is discontinued, although leveraged lever inserted before the effective date of ASC 842 can continue to be accounted for under ASC 840 unless they are modified. The difference between direct-type and direct financing leases has changed: whereas in ASC 840 the test is whether the fair value of a leased asset differs from the cost or amount of the lessor's rent (if so, the lease is a sale-type of lease), in ASC 842, any lessor lease fulfill the lessee's finance lease test (based on the rental price and residual collateral attributable to the lessee) is a sale-type of lease; the direct financing treatment applies if the lease is capital only because the third party guarantee guarantees cause the present value test to be met. The main difference in accounting between sale-type leases and direct financing leases is that profit for sale-type leases is recognized initially, while profit for direct financing leases is recognized over the lease term.
Impact of New Lease Accounting Rule
The US Securities and Exchange Commission (SEC) in 2005 estimated that the company had approximately $ 1.25 trillion in operating lease commitments. By 2015, the forecast has risen to $ 2 trillion. While the FASB stipulates that operating lease obligations should be considered "non-debt obligations," so they do not affect the debt ratio and most of the loan agreements, the addition of the same assets and liabilities will reduce the fast ratio of most companies, while the fact that operating leases create liabilities smoothly but not the current assets reduce the current ratio. Companies estimated to be most affected include retail chains and airlines.
Other Issues
Typically, when a rental is entered, a security deposit is required. There are two types of warranty deposits:
- Non-refundable security deposit: Suspended by the lessor as unearned revenue; Capitalized by the lessee as a prepaid rental fee until the lessor considers the deposit received.
- Refundable security deposit: Treated as a receivable by the lessee; Treated as a liability by the lessor until the deposit is returned to the lessee.
Calculation
How to calculate rental rate:
[Monthly Lease Payment] x [Duration (month)] = [Total Out of the Pocket]
[Total out of pocket] - [Total financed] = [Total cost of finance]
[Total cost of finance]/[Duration (year)] = [Annual cost of finance]
[Annual financial costs]/[Total financed] = Annual Interest Rate
See also
- FAS 13, Rental Accounting
- Project Update under Topic 840
- FASB Topic 840 Documentation
- Accounting Standard Update 2016-02: Lease (Topic 842)
References
Source of the article : Wikipedia
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