Finance Lease

For a finance lease, the lessee debits the fixed asset account by the present value of the minimum lease payments. The credit to lease liability account is the difference between the value of the equipment and cash paid at the beginning of the year. The lessee records depreciation expense on the asset just like any other purchased asset, and the lease liability account is treated just like a note payable with a declining balance.

Operating Lease with Right-of-Use Asset

The calculations may seem complicated at first, but in essence, it is a simple two-step process:

1. Determine the present value of the lease payments
2. Determine the direct payments that are part of the right-to-use asset

Here is an example of the entries you would make for an operating lease that creates a right-of-use asset:

• Assume a six-year auto lease with no renewal options that calls for a $4,000 lease payment, paid at the end of each year.
• The company’s normal borrowing rate is 9%.
• There is an initial direct cost of $1,000.

The lease liability will be recorded as the present value of the six payments, discounted at 9%.

• Therefore, the lease liability would equal $17,943.60
• (Present value of an ordinary annuity of $4,000 at 9% for six years factor = 4.4859)

The right-of-use asset will be recorded as the lease liability plus initial direct costs plus prepayments less any lease incentives

Therefore, the right-of-use asset would be calculated as $17,943.60 (lease liability) + $1,000.00 (direct costs) = $18,943.60

The journal entry would be:

As the lease is paid down, the present value is recalculated and the right-of-use assets are depreciated. The change in the lease is a combination of interest, principal, and amortization.

The exception for leases with a term of 12 months or less permits the lessee to make an accounting policy election not to recognize leased assets and lease liabilities, and instead recognize lease expenses on a straight line basis over the lease term, consistent with the accounting for operating leases under SFAS 13. Basically, this means the lessee debits lease expense for the lease payments when it credits the checking account for the disbursement, and doesn’t have to recognize an asset.