Categorize Highlight Lease For Free

How do you determine if a lease is an operating lease or a finance lease? Well, that is where the lease classification test comes into play. As a guiding principle, if the majority of the assets life is controlled by the lessee, then it should be classified as a finance lease. If not, then it is an operating lease.

Under ASC 840, lease classification (i.e., determining if a lease is a capital or operating lease) was decided when the lease was executed (i.e. lease inception). Under ASC 842, the lease classification (finance or operating) is determined at lease commencement.

There are two categories of leases - operating leases and finance, which determine how a company accounts for leases based on the length of the lease in the financial statements.

If the lease meets any of the criteria, then it must be recorded as a finance lease. The five criteria relates to a bargain purchase option, transfer of ownership, net present value of lease payments, economic life, and whether the asset is specialized.

If the lease meets any of the criteria, then it must be recorded as a finance lease. The five criteria relates to a bargain purchase option, transfer of ownership, net present value of lease payments, economic life, and whether the asset is specialized.

ASC 842 requires both lessors and lessees to determine the classification of all leases at the commencement of the lease. The commencement date would be the date when the lessor makes the underlying asset available for the lessees use.

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.

The two most common types of leases are operating leases and financing leases (also called capital leases). In order to differentiate between the two, one must consider how fully the risks and rewards associated with ownership of the asset have been transferred to the lessee from the lessor.