Defining Finance and Operating Leases Under the New Lease Accounting Standard

Whether a lease should be classified as an operating or a finance lease will be determined in a manner like that used under existing standards. Under Accounting Standards Update (ASU) 2016-02 – Leases (Topic 842) , finance leases are leases that meet any of the  following criteria:

• Ownership is transferred to the lessee at the end of the lease term.
• The lease includes a purchase option that is reasonably certain to be exercised (e.g., a bargain purchase option).
• The lease term is for the major part of the remaining economic life of the lease asset.
• The present value of the lease payments and residual guarantees is equal to or more than substantially all the fair value of the leased asset.
• The leased asset has no alternative use to the lessor due to the specialized nature of the asset.

Operating leases are leases that do not meet any of the above criteria. 

Both types of leases will now be accounted for on healthcare organizations’ balance sheets, although they will be presented separately. The new guidance requires organizations to recognize the right-of-use asset and lease liability for all leases:

• Right-of-use asset: Present value of the prospective lease payments, measured at the time the lease commences.
• Lease liability: Present value of the prospective lease payments, measured at the time the lease commences.

See related article: Bottom-Line Implications of New Lease Accounting Standards: What Healthcare Leaders Should Know