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 [VERIFY classification criteria and thresholds against current ASC 842 guidance].
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. [VERIFY the exact classification criteria.]
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.
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Educational overview only. Confirm lease classification rules against current ASC 842 guidance. Not affiliated with AICPA.