Explain lease accounting
Lease accounting refers to the process of accounting for leases, which are contracts between a lessor (the owner of an asset) and a lessee (the user of that asset) that allow the lessee to use the asset for a specified period of time in exchange for regular lease payments.
The International Financial Reporting Standards (IFRS) and the US Generally Accepted Accounting Principles (GAAP) have different rules for lease accounting. However, both IFRS and GAAP require companies to classify leases as either finance leases or operating leases.
Finance leases are similar to ownership and transfer the risks and rewards of ownership to the lessee. The lessee must recognize the leased asset on their balance sheet and record depreciation expense for the asset as well as interest expense on the lease liability.
Operating leases are more like renting, where the lessor retains the risks and rewards of ownership. The lessee must recognize lease expense on their income statement as well as disclose the future lease payments in the notes to the financial statements.
Lease accounting standards have changed recently, with IFRS 16 and ASC 842 being implemented, which require lessees to recognize almost all leases on their balance sheets as a right-of-use asset and lease liability, regardless of whether they are finance or operating leases. These changes were made to increase transparency and comparability in financial reporting.
Explain lease accounting to a 5 year old
Lease accounting is when someone rents something, like a car or a toy, for a certain amount of time. When they rent it, they have to pay money to the person who owns the thing they’re renting. Lease accounting helps people keep track of how much money they owe and how long they can use the thing they’re renting.