Changes in Lease Accounting

A lease is a contractual agreement between an owner of an asset and a counterparty that intends to utilize that asset in exchange for periodical payments. Examples of assets, often used in lease agreements are real estate, ships, aircraft and cars.

Types of Leases

There are two general types of leases: operating leases and financial leases, also known as capital leases. A key differentiator of these two types of Leases is which party assumes the price volatility of the assets.

Operating Leases

The operating type of lease is near identical to the standard rental contract. The owner assumes all the risk as well as the potential reward of the ownership of the asset.

Capital Leases

A capital lease is a contract whereby the party that leases the assets assumes fully or in part the price volatility of the asset, for example through an option to purchase the asset at the end of the lease period.

Accounting Treatment of Leases

It appears that recent proposals to overhaul the way in which companies account for their operating leases are gaining steam and will have a major effect on the way investors analyze retailers, ship operators and airlines.

Under the current rules, only capital leases are included on a company’s balance sheet, while operating leases are left in a note to the financial statements, undiscounted and clumped together in buckets of years with a giant terminal bucket, making their analysis prone to error.

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