ASC 842 is the accounting standard that governs lease accounting. Under ASC 842, lessors must classify leases as either operating leases or finance leases (previously known as capital leases) and account for them accordingly. Below are examples of journal entries for a lessor under ASC 842 for both types of leases.
1. Operating Lease (Lessor’s Perspective)
In an operating lease, the lessor retains ownership of the asset and recognizes lease income over the lease term.
Example 1: Initial Recognition and Lease Payments
Scenario: A company leases out equipment on January 1, 2024, for $2,000 per month for 24 months. The equipment’s cost is $40,000 with a useful life of 5 years.
a. Initial Recognition:
- The lessor does not derecognize the asset from its balance sheet because it remains the owner.
b. Monthly Lease Payment:
Journal Entry for Monthly Lease Payment:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 01-31-2024 | Cash | 2,000 | |
| 01-31-2024 | To Lease Income | 2,000 |
Explanation:
- Cash will debited to reflect the receipt of lease payments.
- Lease Income will credited to recognize the earned revenue.
c. Depreciation Expense:
Because the lessor retains the asset, it continues to depreciate the asset.
Journal Entry for Depreciation:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 01-31-2024 | Depreciation Expense | 666.67 | |
| 01-31-2024 | To Accumulated Depreciation | 666.67 |
(Assuming straight-line depreciation: $40,000 / 60 months = $666.67 per month)
Explanation:
- Depreciation Expense will debited to reflect the expense.
- Accumulated Depreciation will credited to reduce the asset’s book value.
2. Finance Lease (Lessor’s Perspective)
In a finance lease, the lessor transfers substantially all the risks and rewards of ownership to the lessee. The lessor recognizes a net investment in the lease.
Example 2: Initial Recognition and Lease Payments
Scenario: A company leases out machinery under a finance lease on January 1, 2024. The machinery’s fair value is $50,000, and the lease term is 4 years with annual payments of $15,000. The interest rate implicit in the lease is 5%.
a. Initial Recognition:
Journal Entry to Record the Lease:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 01-01-2024 | Lease Receivable | 50,000 | |
| 01-01-2024 | To Equipment (or Asset Account) | 50,000 |
Explanation:
- Lease Receivable will debited to recognize the net investment in the lease.
- Equipment (or the relevant asset account) will credited to derecognize the leased asset.
b. Receipt of Lease Payment:
Journal Entry for Annual Lease Payment:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 12-31-2024 | Cash | 15,000 | |
| 12-31-2024 | To Lease Receivable | 12,500 | |
| 12-31-2024 | To Interest Income | 2,500 |
(Interest Income: $50,000 x 5% = $2,500; Principal: $15,000 – $2,500 = $12,500)
Explanation:
- Cash will debited for the amount received.
- Lease Receivable will credited to reduce the receivable.
- Interest Income will credited to recognize the interest portion of the payment.
3. Impairment of Lease Receivable (If Applicable)
If there is an impairment of the lease receivable, the lessor must recognize an impairment loss.
Example 3: Recognizing an Impairment Loss
Scenario: The lessor determines that $5,000 of the lease receivable is impaired.
Journal Entry:
| Date | Account Title | Debit ($) | Credit ($) |
|---|---|---|---|
| 06-30-2024 | Impairment Loss | 5,000 | |
| 06-30-2024 | To Lease Receivable | 5,000 |
Explanation:
- Impairment Loss will debited to reflect the loss.
- Lease Receivable will credited to reduce the asset.
These examples cover the basic accounting entries for lessors under ASC 842, depending on whether the lease is classified as an operating lease or a finance lease. The entries reflect the treatment of lease income, asset depreciation (for operating leases), and the recognition of lease receivables and interest income (for finance leases).