Lease Accounting Glossary
Quickly find precise definitions to lease accounting terms
Defining Lease Accounting Topics and Terms
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.
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.
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
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.
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.
Residential Value Guarantee
Straight Line Rent Expense
Tenant Improvement Allowance
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