Understanding Financial and Operational Leasing Contracts

Understanding Leasing Contracts

A lease is a contract whereby one person (Lessor or Landlord) or company transfers to another person (Lessee or Tenant) the right to use a physical asset in exchange for compensation, usually a periodic payment. After a specified time, the lessee has the option to purchase the property, renew the lease, or return the property.

Financial Leasing

A financial lease is characterized by the following criteria:

• a) Ownership is transferred to the lessee by the end of the contract.
• b) The purchase option amount at the end of the contract is significantly below the market value of the goods at that time.
• c) The present value of lease payments represents a significant proportion of the market value of the asset at the beginning of the contract (90% or more).
• d) The contract covers a significant part of the useful life of the asset (75% or more).

Operational Leasing

An operational lease is defined by these features:

• a) Short or medium-term contract.
• b) Voidable; it can be terminated in advance.
• c) Maintenance costs are borne by the Lessor.
• d) No purchase option is included.

Accounting for Operational Leases

Accounting for the Tenant: The tenant records accrued leases in an account of results of operations (loss) by adding an explanatory note to the financial statements. If required, the tenant must activate these as deferred charges and amortize prepaid leases as interest accrues.

Accounting for the Lessor: The lessor posts earned rents to an account of operating income (profit), adding an explanatory note to the financial statements indicating the characteristics and relevant conditions of the contract. Where applicable, the landlord must account for the liability in a deferred income account for rents received in advance and transfer them to operational results as they accrue.

Accounting for Financial Leases

Accounting for the Tenant: The tenant shall record the current value of the contract in a fixed asset account under the name of "Leased Assets," adding an explanatory note to the financial statements indicating the characteristics and relevant conditions of the contract. The face value of the contract must be recorded as liabilities, presented as short or long-term according to the maturity of the respective shares. The difference between the nominal value of the contract and its current value should be accounted for under an asset account entitled "Deferred Interest for Leasing." At the end of each period, the tenant shall transfer to the results the proportion of deferred leasing interest accrued to that date, determined based on the outstanding balance.