Accounting changes cause frustration to both business owners and accountants alike. Although they’re often made for all the right reasons by the governing bodies, they cause stress and unease. Business owners often don’t have the time to keep up with wholesale accounting changes…especially when it’s a niche part of accounting like lease accounting. With Finance lease vs operating lease and the changes regarding the terminology, things can get even more confusing, forcing a business owner to step back and take stock. So, here we explain the difference and tell you how it’ll affect your business.
What’s The New Accounting Standard
Before we explore the finance lease vs operating lease we’ll touch on the lease standards accounting change that operating leases are a part of. The new lease accounting standard is called ASC 842 and it applies to the majority of leases and subleases. It is the new lease accounting standard issued by the FASB. Now, the vast majority of a business’s leases must be recorded on the balance sheet.
Why Do We Have A New Lease Accounting Standards
This one is pretty simple. The new standard was rolled out to ensure a better level of transparency in regards to liabilities on the balance sheet. Previously, these could be “hidden” as off balance sheet activities. For auditors and those assessing a businesses position, previously it was hard to come to fair conclusions when comparing them to businesses without larger lease positions.
Finance Lease Vs Operating Lease
So, what’s the difference and why the change? For a start, finance leases used to be capital leases, under the old ASC 840 guidelines. The classification of a lease (finance or operating) tells us how they should be treated for accounting. So, what’s the difference when looking at a finance lease vs operating lease? The two have similarities, but in short, operating leases do require lease expenses to be recognized in the accounts on a straight-line basis over the whole term of the lease. Whereas a finance lease (used to be a capital lease) requires the person leasing the asset (lessee) to recognize amortization and interest expense (higher at first, but then decreasing over the term).
What’s Better For Your Business
It depends on your business, and where you are in your business journey. As a start up, bearing more costs at the start of the lease might not be a good idea. Newer businesses need the capital. With an operating lease, you’ll know exactly where you are at all points in the lease. However, if you’ve got capital and foresee some heavy spending later in the life of your business it might be easier to actually start heavy and decrease overtime.
Get Your Accounting On Point
Either way, it’s important to properly account for finance and operating leases in line with the new accounting guidelines. If you do your own accounting, and utilize a lease structure, then this is the time to get to grips with what’s going on. If it’s a bit too much for you to do while running a business you’d do better off using lease accounting software or hiring an accountant.
About the Author/s
The New Jersey Digest is a new jersey magazine that has chronicled daily life in the Garden State for over 10 years.
