Leases typically fall into two primary categories:
- Finance Leases (or capital leases): These leases effectively transfer ownership rights and responsibilities from the lessor to the lessee. Assets leased under a finance lease are reported on the lessee's balance sheet as both an asset and a corresponding liability. The organization recognizes depreciation and interest expense throughout the lease term.
- Operating Leases: These leases are more like traditional rental agreements. The organization does not assume the risks and benefits of ownership, and the leased asset generally does not appear on the balance sheet. Lease payments are recorded as operating expenses, simplifying accounting and budgeting.
Accounting standards such as GASB 87 and ASC 842 provide specific guidance for identifying and classifying leases correctly.
Proper lease classification helps organizations maintain compliance, prepare accurate financial statements, and make informed decisions about resource allocation and financial planning.
Why Lease Accounting is Important
Lease accounting plays an important role in maintaining financial transparency and accountability. For organizations in public finance, including governments, nonprofits, healthcare systems, and higher education institutions, leases often represent significant financial obligations. Proper lease accounting helps organizations:
- Accurately reflect lease liabilities and assets on financial statements
- Comply with standards such as GASB 87 and ASC 842
- Make better budgeting and capital planning decisions
- Ensure audit readiness and improve stakeholder trust
Understanding lease obligations and recording them correctly supports responsible financial stewardship and long-term sustainability.
What’s important here?
A lease in accounting is a contractual arrangement that grants usage rights for an asset over a defined period. Leases are categorized as either finance leases, which transfer ownership risks and appear on balance sheets, or operating leases, which function as rentals without significant balance sheet impact.
Correctly identifying and accounting for leases ensures compliance and accurate financial reporting in public finance sectors.
