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Explanations of the Different Types of Leases in Accounting Terms

Explanations of the Different Types of Leases in Accounting Terms

Types of Leases

The three main types of leases are finance leases, operating leases, and contract hire. All these can be taken care of with accounting software such as EZLease.

We still need to know something about them, however, but less when the right software is guiding us to the answers and ensuring that the various account standards are being paid attention to. Failure to do that can result in significant financial penalties for a business handling leases.

Finance Lease

Finance Lease

A finance lease is a long-term lease. This will be over the life of the equipment. It can be for three years, and sometimes longer. After which time, a nominal rent might be paid, or the piece of equipment scrapped because it has gone beyond its useful life.

A leasing company will look to recover the full cost paid for the equipment that it has leased, along with charges, over the period that the lease is for.

Those leasing the equipment will be responsible for maintaining it and insuring it unless other arrangements have been made.

In accounting terms, the leased asset must show on a balance sheet as a capital item, or one bought by the company. This is the law now for both public and private companies. Those leases over five years will be referred to as “long funding leases”, which will allow capital allowances to be claimed for them where the asset has been bought outright.

Leasing accounting software will make the process of recording and keeping track of this type of lease easier.

Operating Lease

Now, to operating leases. These are ideal for businesses when they do not require the equipment to be leased to them for the entire working life of that piece of machinery. The principle is that the leasing company will take the asset back once the term of the lease has expired.

With these kinds of arrangements, the leasing company will be responsible for the maintenance and insurance of the equipment.

This is obviously in their interests now. Once they have the piece of machinery back after the lease has expired, they will be looking to lease it to someone else, or back again to the same company. The lessor will be looking to obtain enough money from his lessees to pay for the entire cost of buying the piece of equipment and to make a profit on the arrangement over time.

This particular type of lease does not need to be shown on a balance sheet. Lease accounting software should guide you to this fact. Leases must be treated differently and correctly to satisfy updated accounting standards.

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Contract Hire

Contract Hire

This is a type of leasing that concerns company cars. The leasing company will be responsible for the maintenance and management of the vehicle in respect of servicing and repairs.

Again, this does not need to show on the balance sheet. It is the finance leases that do. When a company participates in a lot of finance leases, it will be particularly important to have accounting software that takes care of the recording process and keeps track of how much is due and when.

We can see then how much you need to know about the various kinds of leases to account for them correctly. With software as our ally, this process can be made far easier and less problematic. The important thing to note is that no matter what, we need to correctly adhere to the accounting standards. In particular, in respect of leases, ASC 842, GASB 87, and FRS 16.

They are what every finance department that deals with leases will worry about getting right. It will be hard to get it wrong, however, when a good lease accounting software package is used and put into operation within a busy accounts department that is involved with many leases.

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