Lease Accounting Glossary
Quickly find precise definitions to lease accounting terms
Defining Lease Accounting Topics and Terms
Capital Lease
A capital lease is one in which a lessee records the leased asset as if it purchased the asset using funding provided by the lessor. As a result, capital lease accounting under current GAAP is actually comprised of two transactions: A purchase of the underlying asset by the lessee and a loan to the lessee from the lessor to fund the purchase of said asset.
A lessee should record a lease as a capital lease and therefore apply capital lease accounting if ANY of the following criteria are met:
- First Criterion: Ownership of the underlying asset transfers to the lessee after the lease term; or
- Second Criterion: There is a “bargain purchase option”, meaning that the lessee has an option to buy the underlying asset after the lease term at a price that’s below-market; or
- Third Criterion: The lease term is 75% or greater than the useful life of the underlying asset; or
- Fourth Criterion: The present value of the minimum lease payments is at least 90% of the fair value of the asset.
FAS 13
The lease accounting standards in place before the boards began the project to standardize the codification that resulted in ASC 840.
FASB Topic 842
FASB topic 842, or FASB ASC 842, refers to the new lease accounting guidance, Accounting Standard Codification 842 for Leases. The newly-published lease accounting standard for US public companies and private companies issuing GAAP statements. Under the new standard, the key changes include the classification of leases, operating leases being recognized on the balance sheet, and additional disclosures in the financials.
Read more about the upcoming lease accounting changes under FASB Topic 842 >>
Free Rent
A lease has free rent or free rent periods when a landlord does not require payments of rent during specific periods within the lease term. Free rent usually results in deferred rent under topic 840, as the rent payments have to be straight-lined through the lease term. In ASC 842, the free rent periods will result in a lower lease liability (because the liability is calculated as the present value of future rent payments), which also results in a lower right of use (ROU) asset, because the ROU asset is calculated starting from the lease liability.
FASB Topic 840
Refers to the lease accounting rules established in 1973 that were previously within FAS 13. These rules were called ASC 840 after the codification, and they will be replaced with Topic 842 effective 2019 for public companies and 2020 for private companies.
Finance Lease
Similar to a capital lease under ASC 840, any lease that passes any 1 of the 5 tests under ASC 842 that include bargain purchase option, transfer of ownership, fair value test, useful life test, and finally the unique use test.
Functional Currency
The currency of the primary economic environment in which the entity operates. Simply put, it is the currency the subsidiary transacts on a day to day basis, which could be different than the reporting currency of the entire entity.
Lease Incentive
A generic name for an amount paid to entice the lessee to enter into a lease agreement with the lessor. This typically takes the form of a tenant improvement allowance to allow companies to make a space their own.
Local Currency
Also called transactional currency. The local currency is currency in which the lease transaction is denominated. Simply put, it is the currency in which the lessee pays the lessor.
Operating Lease
Any agreement between lessor and lessee in which the lessor grants the right to use an asset for a specified period that is less than the useful life of the asset and the lessee agrees to make payments for the right to use the asset that is less than the fair value of the asset. Upon the end of said term, the lessee does not own nor have the option to purchase the asset.
Read a full guide on transitioning to operating leases under the new lease accounting standard.
Rent Abatement
Another term for “free rent”, discounted and/or free rent given by the landlord for a specific period of time. Typically we see this at the beginning of a lease to encourage signature.
Reporting Currency
The currency in which an organization reports their total consolidated financials.
Residential Value Guarantee
The guaranteed value of the leased asset to the lessor at the end of the term. Sometimes this will require the lessee to make a cash payment to cover the difference of the fair value of the asset and the residual value guarantee in the lease.
Straight Line Rent Expense
The method GAAP requires for accounting for lease expense. To calculate straight-line rent expense you simply total all future commitments and divide by the appropriate number of periods. Simply put, this is consideration of the total lease payment (total rent expense) for the lease term that is evenly divided by the number of months in the term.
Tenant Improvement Allowance
An incentive given to the lessee to encourage execution that is specifically for making improvements on the property or asset. This amount will be amortized straight line for the term of the lease as a reduction in monthly expense.