Classify Spreadsheet Lease For Free

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.

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.

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.

A lease will be recorded on the balance sheet as a right-of-use (ROU) asset and lease liability. The lease liability is the payment obligation over the term of the lease contract, while the ROU asset represents the control of the asset under the lease contract.

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.

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.

A lease will be recorded on the balance sheet as a right-of-use (ROU) asset and lease liability. The lease liability is the payment obligation over the term of the lease contract, while the ROU asset represents the control of the asset under the lease contract.

Operating leases require lease expenses to be recognized on a straight-line basis over the lease term, whereas finance leases (just like capital leases) require the lessee to recognize interest expense and amortization expense, which means expenses will be higher at the beginning of the lease and decrease over time.

Conclusively, the present value of the minimum lease payment is simply the sum of all of the lease payments that are to be made in the future, in today's dollar terms, added to the value of the estimated value of the leased asset once the lease is over.