FAS 13/IAS 17 Methodology
Operating Example: Office Lease
Operating rent expense |
5,500.00
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Deferred liability |
500.00
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Cash |
5,000.00
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Monthly journal entry (second 5 years)
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Note: At the end of the life of the lease, the deferred liability will be zero. If a lease is terminated early, you recognize a gain equal to the balance in the deferred liability account (because rent that you have expensed will not actually need to be paid). Any termination penalty is an offsetting loss. In some cases, governmental entities need not level the rent as shown above. Under Governmental Accounting Standard #13 (GAS 13), rents may be expensed as incurred, even when they change during the life of the lease, "when the pattern of the payment requirements, including the increases, is systematic and rational." Increases in the rent due to actual or anticipated inflation are specifically listed as qualifying examples. In such cases, no deferred asset or liability is recognized; each month, operating rent expense is debited and cash is credited for the actual rent payment. (Note that the governmental lease accounting standard is currently in revision, with a new standard expected to be implemented in 2020.) You also need to disclose your future rent commitments. At the end of the first year, for example, you have four years of $5000 per month rent remaining, plus five years of $6000 per month. (Future rent commitment disclosure is based on cash, not accrual, rent.) So as of the end of year 1, your disclosure would be:
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The following is a schedule by years of minimum future rentals on noncancelable operating leases as of December 31, 20X8:
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Year ending December 31, |
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20X9: |
60,000
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20X0: |
60,000
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20X1: |
60,000
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20X2: |
60,000
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20X3: |
72,000
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Later years: |
288,000
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Total minimum future payments required: |
600,000
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To enter this lease in the trial version of EZLease, follow these steps:
- Enter a Begin Date (such as January 1, 2010)
- Double-click on the Lease Term; in the box that appears, enter 120 (or enter an end date that makes the lease term 120 months exactly, which will be one day earlier in the year than the begin date, such as December 31, 2019)
- Set the Classification According To to FAS 13 (or IAS 17, if you have set EZLease to IFRS accounting).
- Leave Classification as "To be classified" and Capital Rate blank, so EZLease can determine it
- Click on the Main data tab, if it is not already present
- Enter Gross Rent on the first line of 5000
- Enter a Step End date 5 years after the begin date (such as Dec. 31, 2014)
- On the second rent line, enter Gross Rent of 6000; the Step End date matching the end of the lease does not need to be changed
- Enter Economic Life of 360 (30 years)
- Click on the Inception tab
- Check the box that reads Fair Value Not Determinable
- Click Save. The classification is updated to Operating.
See the other tab for operating lease accounting under the new lease accounting standards ASC 842 & IFRS 16 (effective for most companies in 2019).
A Reliable, Tested Solution
Also test out our Asset Retirement Obligations reporting in the trial version of either EZLease or EZ ARO
ASC 842/IFRS 16 Methodology
Operating leases under IFRS 16
IFRS 16 does not have an official "operating" category for leases. However, there are two exceptions to the general rule that all leases are finance:
- A lease with a total lease term, including available options (even if not considered reasonably certain of exercise), of 12 months or less.
- A lease of a "low value" asset (defined by the IASB as an asset which, when new, would have a fair value of less than approximately US$5,000.
Such leases are excluded from normal IFRS 16 reporting; they do not have to be shown on the balance sheet, and are simply expensed on a straight-line basis, like IAS 17 operating leases are.
Existing IAS 17 leases which do not fall under these exclusions are capitalized according to the remaining rent at transition to IFRS 16.
Operating Example: Office Lease (ASC 842)
Account | Debit | Credit |
Right-of-use asset |
540,116.39 |
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Current liability |
40,974.66
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Long term liability |
499,141.73
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(Initial booking) | ||
Current liability |
3,216.28
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Operating lease cost | 5,500.00 | |
Cash |
5,000.00
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Accumulated depreciation |
3,716.28
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(Monthly rent payment) | ||
Long term liability |
3,336.19
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Current liability |
3,336.19
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(Liability reclassification, long term to current) |
The accumulated depreciation activity for the period is calculated as the sum of change in liability (rent paid of 5,000, minus 1,783.72 interest accrued) plus the 500 difference between cash and straight-line rent. If a lease has initial direct costs or lease incentives to amortize, those are also included in the asset and the calculation of the depreciation. Depreciation and interest are not expensed directly, but only within the "operating lease cost."
You also need to disclose your future rent commitments. At the end of the first year, for example, you have four years of $5000 per month rent remaining, plus five years of $6000 per month. So as of the end of year 1, your disclosure would be:
The following is a schedule by years of minimum future rentals on noncancelable operating leases as of December 31, 20X8:
Year ending December 31, |
|
20X9: |
60,000
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20X0: |
60,000
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20X1: |
60,000
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20X2: |
60,000
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20X3: |
72,000
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Later years: |
288,000
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Total minimum future payments required: |
600,000
|
Less imputed interest | 99,194 |
Net present value of future lease payments | 500,806 |
To enter this lease in the trial version of EZLease, follow these steps:
- Enter a Begin Date (such as January 1, 2017; needs to be on or after the ASC 842 transition date as specified in System Options, New Standard tab)
- Double-click on the Lease Term; in the box that appears, enter 120 (or enter an end date that makes the lease term 120 months exactly, which will be one day earlier in the year than the begin date, such as December 31, 2026)
- Set the Classification According To to ASC 842. (Under IFRS 16, this lease will be finance.)
- Leave Classification as "To be classified" and Capital Rate blank, so EZLease can determine it
- Click on the Main data tab, if it is not already present
- Enter Gross Rent on the first line of 5000
- Enter a Step End date 5 years after the begin date (such as Dec. 31, 2021)
- On the second rent line, enter Gross Rent of 6000; the Step End date matching the end of the lease does not need to be changed
- Enter Economic Life of 360 (30 years)
- Click on the Inception tab
- Check the box that reads Fair Value Not Determinable
- Click Save. The classification is updated to Operating.
See the other tab for operating lease accounting under the old lease accounting standards FAS 13 (ASC 840) & IAS 17.
A Reliable, Tested Solution
See also our examples of finance (capital) lease accounting for FAS 13/IAS 17 and for ASC 842/IFRS 16.
Also test out our Asset Retirement Obligations reporting in the trial version of either EZLease or EZ ARO