Lease Accounting and What We Need to Know

A lease is defined as a transaction that a company makes to have the right to use an asset. This, like any other financially-based transaction, needs to be accounted for in a timely and accurate manner. Thankfully, these days, software exists to make accounting for leases easier and quicker in terms of recording, gathering, and reporting the information.

How Does a Lease Work?

With a lease, a company will pay the other party an agreed-upon sum in exchange for the use of an asset. The asset can be a vehicle that is used for deliveries or plant hire that is used on a construction job. The latter is likely to be a shorter-term lease because the equipment may well be returned after a particular construction project has been completed.

Leases are popular with businesses as opposed to buying an asset because no down payment will be required, the monthly payments are generally lower than with bank loans, and a lease is easier to obtain where there are bad credit ratings to consider. So, there is certainly a market for leases and much to account for to keep track of them. The thing to be aware of with leases is that there can be mileage restrictions and the potential for extra fees for early terminations. This will all be in the small print and need to be taken note of on both sides where extra payments are involved.

Accounting for a Lease

Lease accounting is an important section of accounting and should be taken extremely seriously in terms of recording things accurately. Rules exist to govern the way leases are, for instance, defined. In fact, in most cases in the future, it will be as capital leases, albeit the ones that are for less than 12-months, which remain classed as operating leases.

In an accounting ledger, whether it be a paper record or a computerized one where there will be less chance of misreading figures, a journal entry will be required. This consists of debiting the lease asset account and, at the same time, crediting the lease liability account. The amount of lease asset or liability should be recorded as the fair value in terms of the total lease payments. The idea of debits and credits follows the convention of the double-entry bookkeeping system.

The principle behind double-entry bookkeeping, which computer software will take care of, as long as you enter everything from both sides, is that every financial transaction has equal and opposite effects in two different accounts. Where software accounting tools are used, all these separate accounts will be automatically integrated by the lease accounting software and appear as totals on the balance sheet to be reported on. Figures are then instantly accessible for monthly and year-end audit situations.

There are just three basic rules to accounting, whether to do with lease accounting or not:

Debit the receiver and credit the giver.

Debit the incoming and credit the outgoing.

Debit all expenses and losses but credit all income and gains.

If you know these rules, you cannot go far wrong with regards to the placement of figures in the accounts. The software can help you with this.

Accounting Standards

There is an added complication with lease accounting because there are more accounting standards to know. For instance, concerning how, in the future, leases need to be classified from a balance sheet point of view. In the past, it has not always provided a full picture to shareholders when the details of all leases were not visible. To rectify this, in the future, leases will need to primarily be recorded as capital ones, rather than be split between finance and operating leases. When they are longer than 12 months, that is.

So, it pays to know all the different accounting standards to accurately record figures in the leasing sections of your accounts. It is, after all, these figures that will ultimately be reported.

In conclusion, we need to think of the way that we record leases in our account in terms of there being debits and credits to record for each transaction and know that in the future leases will need to be predominantly recorded as capital leases. Lease accounting software exists to help us with all of this so that we can accurately record and report our lease figures in an accurate and timely way.

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