What is a lease you may be asking yourself? Well, a lease is a contract, or part of a contract, which 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. Control over the use of the identified asset means that the customer has both (1) the right to obtain substantially all of the economic benefits from the use of the asset and (2) the right to direct the use of the asset.
Under the new lease standard (Topic 842) there are three types of leases: finance lease, operating lease, and short-term lease.
- Finance lease – a lease that meets one or more of the following criteria:
- The lease transfers ownership of the underlying asset to the lessee by the end of the lease term.
- The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise.
- The lease term is for the major part of the remaining economic life of the underlying asset. However, if the commencement date falls at or near the end of the economic life of the underlying asset, this criterion shall not be used for purposes of classifying the lease.
- The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease payments equals or exceeds substantially all of the fair value of the underlying asset.
- The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.
- Operating lease – any lease other than a finance lease or short-term lease (when none of the above or below criteria are met).
- Short-term lease – generally refers to a lease with a duration of twelve months or less and does not include a purchase option that is reasonably certain to exercise.
Finance leases and operating leases will be presented on the statement of financial position under the new lease standard. Short-term leases can be expenses and do not need to be reported on the statement of financial position.
Everyone should be making sure they can track down all of their lease agreements and thinking of what you can be doing to prepare to implement the changes needed to adopt the new lease standard, as it will be effective for the current year by the time you are reading this. If you have any questions about the new lease standard, please contact your Henry+Horne advisor.
Steven Taylor, CPA