Advanced Topics
In a nutshell: Leases require recording both assets and liabilities, giving a clearer picture of a company's commitments.
## Accounting for Leases
Leasing is when one party (the lessee) uses an asset owned by another (the lessor) for a fee. New accounting standards (ASC 842) changed how leases are reported for greater transparency.
### Types of Leases
- **Finance Lease:** Treated like a purchase. The lessee records both an asset and a liability.
- **Operating Lease:** The asset is used temporarily; both right-of-use asset and lease liability are recorded, but expenses are recognized differently.
## Key Steps
1. Calculate the present value of future lease payments.
2. Record a right-of-use asset and a lease liability on the balance sheet.
3. Recognize interest and amortization expenses (finance) or straight-line lease expense (operating).
## Real-World Impact
Lease accounting affects key financial ratios and borrowing capacity. Transparent reporting helps investors spot off-balance-sheet financing.
PV = \frac{C}{(1 + r)^n}
Examples
- A company leases office space for 5 years and records both a right-of-use asset and a lease liability.
- A retailer enters a 10-year equipment lease, impacting its balance sheet and expense recognition.
Key terms
- Right-of-Use Asset
- An asset that represents a lessee's right to use a leased asset over the lease term.
- Lease Liability
- A liability reflecting the present value of future lease payments.