Lease classification

The Financial Accounting Standards Board (FASB), the International Accounting Standards Board (IASB), and the Governmental Accounting Standards Board (GASB) guidelines require that the lease classification must be set according to defined guidelines as of the commencement date of the lease to determine the appropriate accounting treatment.

Under FASB ASC 840, a lessee can classify a lease as either an Operating lease or a Capital lease. Rent expense under an operating lease is generally recognized on a straight-line basis over the lease term regardless of the timing of the actual rental payments. Under a Capital lease, a lessee must record a Capital lease asset and liability at lease commencement equal to the NPV of the minimum lease payments (generally by using the IBR). The Capital lease asset is amortized on a straight-line basis over the lease term while the liability is amortized by using the IBR.

Under FASB ASC 842, a lessee can classify a lease as either an Operating lease or a Finance lease. A Finance lease is accounted for in a manner similar to a Capital lease under ASC 840 where an ROU asset and a lease liability are recorded equal to the NPV of the lease payments. Under an Operating lease, an ROU asset and lease liability is recorded at lease commencement, but the lease expense is recognized evenly over the lease term.

Under IFRS 16, GASB 87 Lessee, GASB 96, and GASB 87 Lessor, the concept of an Operating lease does not exist. Generally, all leases are recorded as a Finance lease. An ROU asset and lease liability are recorded as of lease commencement. The asset is amortized on straight-line basis over the lease term while the liability is amortized by using the IBR.

In IBM® TRIRIGA®, if the GAAP (FASB) accounting standard is selected, the appropriate accounting schedules are generated for Capital versus Operating leases (for ASC 840) and for Finance versus Operating lease (for ASC 842). If the IFRS (IASB), GASB 87 Lessee, GASB 96, and GASB 87 Lessor accounting standard is selected, an accounting schedule for Finance lease is generated.

Figure 1. Flow diagram for deciding the lease classification
Flow diagram for deciding the lease classification