“Lease accounting” might not top the list of cocktail party conversation starters, but for finance and accounting professionals, it’s a foundational part of clean books, audit readiness, and staying compliant with ever-evolving standards.
Whether you’re a CPA firm managing hundreds of lease portfolios or a corporate controller juggling equipment and office space leases, understanding lease accounting will save you time, reduce compliance headaches, and even strengthen client relationships.
So, what is lease accounting? Why does it matter? And how can you make it a little less painful? Let’s break it down.
Lease accounting is the process of recording and reporting lease agreements in an organization’s financial statements. Historically, many leases flew under the radar as simple operating expenses. But thanks to modern accounting standards, most leases now show up front and center on the balance sheet.
At the heart of every lease is an agreement between two parties: the lessor, who owns the asset and grants the right to use it, and the lessee, who pays to use that asset over a defined period. Today’s standards require lessees to recognize:
This treatment helps stakeholders see the true impact of leases on the company’s financial health.
Lease accounting isn’t just a compliance box to check—it affects every part of your financial reporting process. Here’s why getting it right matters:
Several standards define how to handle lease accounting depending on your industry and location:
The U.S. standard under GAAP, ASC 842 requires lessees to recognize nearly all leases on the balance sheet, with a few exceptions for short-term leases. The standard impacts how you calculate lease liability, track interest expense, and prepare financial disclosures.
IFRS 16 aligns closely with ASC 842 but applies internationally. It eliminates the distinction between operating and finance leases for lessees and puts nearly all lease obligations on the balance sheet.
GASB 87 addresses lease accounting for governments, while GASB 96 focuses on subscription-based IT arrangements (SBITAs). These rules add a whole new layer of complexity and require different treatments for lease vs. subscription assets. Here’s a deeper dive on how GASB 87 and 96 impact financial reporting.
Under ASC 842, lessees are required to recognize nearly all leases on the balance sheet, but leases are still classified into two categories: operating leases and finance leases (formerly known as capital leases under ASC 840). While the initial balance sheet treatment is similar, the income statement impact is what sets them apart.
Operating leases are typically used for assets that are not intended to be purchased, like office space or IT equipment. These leases result in a single, straight-line lease expense on the income statement, with no separate interest or amortization components.
Finance leases are used when the lessee effectively takes on the risks and rewards of ownership. These leases split the expense into interest and amortization, often resulting in higher interest expenses in the early years of the lease term.
Understanding the distinction between these two types is important not just for compliance but for budgeting, forecasting, and stakeholder communication as well.
Not all leases are obvious. Embedded leases are arrangements that look like service contracts but grant the right to control the use of a specific asset, like servers, equipment, or even a retail location.
Under ASC 842 and IFRS 16, if a contract conveys the right to control the use of a specific asset for a period of time in exchange for consideration, that portion of the contract qualifies as a lease—even if it’s not explicitly labeled as one.
Key considerations when identifying embedded leases:
Identifying embedded leases is important for compliance and accurate financial reporting. They’re commonly overlooked during initial reviews, especially when teams rely on manual methods.
Lease accounting doesn’t end once the initial leases are recorded. Day-two accounting refers to the ongoing tasks required to maintain accurate lease accounting over the life of the lease and manage new leases.
These include:
Day-two events can significantly affect the balance sheet and income statement, making it essential to maintain accurate records and revisit lease assumptions periodically. Clear documentation and updated amortization schedules help ensure compliance and support audit readiness.
A sale-leaseback transaction occurs when an entity sells an asset and then leases it back from the buyer. This is often used to free up cash while retaining operational control of the asset.
Under ASC 842, a sale is only recognized if control of the asset transfers to the buyer. If the arrangement does not qualify as a sale, it’s treated as a financing transaction.
Accounting considerations include:
These transactions can be complex and should be evaluated carefully for both financial reporting and compliance purposes.
While much of ASC 842 focuses on lessees, there are important updates for lessors as well. Lessors must classify leases into one of three types:
The classification impacts how and when income is recognized, as well as how assets and receivables appear on the balance sheet. Lessors must also meet new disclosure requirements under ASC 842.
The introduction of ASC 842, IFRS 16, and GASB 87/96 was driven by a desire for greater transparency and comparability in financial reporting.
Previously, many lease obligations were kept off the balance sheet, limiting visibility for investors, auditors, and internal stakeholders. By requiring most leases to be recognized as both assets and liabilities, the updated standards aim to:
Understanding the “why” behind the standards can help teams better anticipate how lease accounting will continue to evolve—and why it's worth investing time and resources in getting it right.
Let’s face it: Excel wasn’t built for lease accounting. Between complex calculations, evolving standards, and constant updates to lease agreements, spreadsheets can quickly become a risky, error-prone mess. Specialized lease accounting software, like Crunchafi’s Lease Accounting solution, helps:
Plus, software reduces manual workload, minimizes errors, and helps you focus on what really matters—advising clients and supporting strategic growth.
Whether you’re managing a handful of leases or hundreds, Crunchafi is here to help. Get in touch with us today or schedule a quick demo, we’d love to show you how we put the ease in lease accounting.
