Comprehensive Accounting Notes on Leases

Overview and Key Provisions of Leases

• Definition of a Lease: A contract, or part of a contract, that conveys the right to control the use of identified property, plant, or equipment (PPE) for a period of time in exchange for consideration.

• Consideration: Consideration does not have to be cash; it can consist of non-cash items, favors, or other non-monetary value.

• Parties Involved in a Lease:

  • Lessee: The entity obtaining the right to use the underlying asset for a period of time.
  • Lessor: The entity that enters into the contract to provide the right to use an underlying asset. The lessor is typically the owner of the asset.

• Key Provisions of a Lease:

  • Lease Payments: Payments can consist of fixed payments, variable lease payments (which may be based on interest rates or indexes), bargain purchase options, or cash payments for residual value guarantees or residual value.
  • Lease Term: The period during which the lease is in force, including any extension periods that are reasonably expected to occur. Short-term leases defined as 12 months or less qualify for operating lease treatment.
  • Residual Value: The estimated fair value of the leased asset at the end of the lease term. Lessors do not necessarily expect lessees to consume the asset entirely; the remaining asset can be sold or re-leased (e.g., commercial copiers).
  • Bargain Purchase Option (BPO): An option granting the lessee the right to purchase the leased asset at a price sufficiently lower than the expected fair market/residual value at the exercise date, such that exercise of the option is reasonably assured at lease inception.