Lease Accounting Basics (CPA FAR)
Lease accounting is a dependable FAR topic and a frequent stumbling block. The key shift under current standards: almost every lease now appears on the balance sheet.
Key Takeaways
- Under ASC 842, almost every lease — finance or operating — now appears on the balance sheet.
- Both lease types record a right-of-use asset and a lease liability at commencement.
- Finance leases front-load total expense (amortization + interest); operating leases use a single straight-line expense.
- A lease is finance if it effectively transfers control — e.g. ownership transfer, bargain purchase option, or the term covers most of the asset's life — otherwise it's operating.
The two lessee models
A lessee classifies a lease as finance or operating. Either way, at commencement the lessee records:
- a right-of-use (ROU) asset — the right to use the asset, and
- a lease liability — the present value of future lease payments.
The difference is how expense flows through the income statement afterward.
Finance vs operating — what changes
| Finance lease | Operating lease | |
|---|---|---|
| Balance sheet | ROU asset + lease liability | ROU asset + lease liability |
| Income statement | Amortization + interest (front-loaded total expense) | Single straight-line lease expense |
| Cash flow | Principal in financing, interest per policy | Operating outflow |
A lease is generally a finance lease if it effectively transfers control — for example, ownership transfers, a bargain purchase option exists, the term covers most of the asset's life, or the present value of payments is substantially all of the fair value. Otherwise it is operating.
Why it matters for the exam
Simulations often ask you to build the lease liability (a present value calculation — see time value of money) and then split each payment between interest and principal. Practice the amortization schedule until it is automatic.
Drill FAR simulations with our diagnostic practice questions, and compare FAR coverage in our best CPA review courses.
Educational overview only. Confirm lease classification rules against current ASC 842 guidance. Not affiliated with AICPA.