Lessor and Lessee
Lessee - the person who pays a rent to use the leased asset
Lessor - owner of the asset being leased
Lease Classification
Rental of property or equipment are classified as either
1. operating lease or
2. capital lease/finance lease. - Asset must be capitalized in the books of the Lessee at the present value of the lease payments. Lessee must also record the interest expense and depreciation of the leased asset.
To be qualify as capital lease, ANY of these criteria must be met:
a. transfer of ownership at the end of lease contract
b. includes bargain purchase option ( where purchase price is less than the market value of the asset)
c. present value of lease payments is greater than 90% of asset's market value
d. lease period is at least 75% of asset's useful life
Related Accounting Standards
IFRS 16 vs ASC 42
LESSEE - (IFRS 16)
In the new standard, lessee will classify all leases as finance lease, eliminating the operating lease classification. If lease term is more than 12 months, a lessee is required to recognize assets and liabilities arising from lease unless the underlying asset is of low value.
LESSEE (ASC 42)
ASC 42 is the new lease accounting standard issued by the FASB for all public and private entities using US GAAP. In the new standard, both under operating and capital lease, lessees are required to recognize assets and the liabilities arising from their leases.
The lessee will need to compute the present value of future expected lease payments to establish asset and liability from the lease contract.
This new standard affects mostly those leases classified as operating lease. Under the old standard ASC 40, leases classified as operating are not required to recognize any leased asset or leased liability in the balance sheet.
LESSOR (IFRS 16)
Lessor will continue to determine lease classifications as either operating or finance. Under operating lease, lessors will record revenue using straight line basis over the lease term. If lease is classified as finance lease, the lessor will calculate the present value of future expected lease receipts and record this amount as a receivable. Lessors are also required to derecognize the carrying value of the underlying asset and recognized any gain or loss on the income statement.