Leasing is a process of allowing your real estate property or business assets to be used by another party at a cost of something in exchange or some capital. Leasing is done by framing a contract that can absorb all the conditions and requirements of the parties involved in the leasing process. Such contracts and agreements are legal and time-bound of a particular period.
Lease accounting refers to the assets and capital exchanges between the investor and the company for utilizing them for mutual benefits. In lease accounting both the party involved report and account the details of the leases differently. The lessor is the investor and lessee is the company owner. The lessee has to pay some amount of interest and the main asset value periodically to the lessor as mentioned in the contract. The most common of all the business leases are operating lease and finance or capital lease.
Operating lease processes a contract that does not give asset ownership right to the lessee but allows to use of it. This lease is often kept off-balance as it states that the leased assets and the liabilities it causes are not the responsibility of the lessor. The details of all these expenses are not added to the company’s balance sheet, it helps to maintain the ratio of debt too equity low. This practice has enabled many firms to unrecord millions and billions of transaction assets and liabilities from the balance sheet.
The establishment of the body named the Financial Accounting Standard Board has passed several rules for public companies on recognizing leases records on the balance sheet if their company existence is not less than 12 months. Operating leases are functioned to meet certain requirements of the Generally Accepted Accounting Principles (GAAP). Companies are asked to test conduct a ‘bright-line test’ that can specify the rental contract should be booked as an operating or capital lease. According to the present GAAP rules, the lease would be considered as a capital lease it does not follow the mentioned characteristics.
Opposite to operating lease, a capital lease is long-term funding in which the lessee is treated as the owner and all the details of the asset and liabilities are recorded in the balance sheet. The term debt is used to mean the capital lease. This lease decreases with time as the lessee keeps on paying the interest and the actual amount in installments. The characteristics of the capital lease include:
Leasing has several advantages to offer that attracts the customer due to the benefits it provides to the customers. The advantages are listed below:
The criteria defined and decided for operating and capital lease accounting are given by the International Financial Reporting Standards (IFRS). It outlines some criteria that help to meet the different attributes of the leases under Accounting Standards for Private Enterprises (ASPE). If any of the following mentioned criteria match with your criteria the lease can be considered.
1. The exposure to have a bargain purchase option in which the lessee has been provided with an option to purchase the price at a lower price than its real price. This option is given only in the beginning period.
2. The timeframe of the lease can not be anything shorter than 75% of its economic life for better benefits and returns.
3. The Net Present Value of the lease payment needs to be at a minimum of 90% against the asset’s real value.