11 Advantages Of Lease Accounting For Businesses

Accounting for lease agreements is required when two parties are involved: the lessor and the lessee. The lessee obtains the right to use the asset in exchange for rental payments from the lessor, who owns the asset legally. 

Accounting and reporting for leases can affect financial statements and ratios in several ways. Therefore, it is necessary to report and account for the leases accordingly.

Leasing is becoming more popular than purchasing as the demand for fixed assets increases. When evaluating a lease versus a purchase, it is important to consider the return on investment.

Understanding lease accounting can help you determine how it can benefit your business.

What Is Lease Accounting?

A lease accounting process records the financial impact of leases or financing agreements, commonly referred to as leasing. Due to recent accounting pronouncements, lessees and lessors must now account for and report their leases differently. 

Lease accounting is governed by accounting standards set by several rule-setting organizations, including the Financial Accounting Standards Board (FASB) and Government Accounting Standards Board (GASB) in the U.S. and the International Accounting Standards Board (IASB).

According to the new standards, businesses must recognize lease assets and liabilities on their balance sheets. The lessee must calculate the present value of future lease payments to establish a lease liability and the related ROU. Companies can learn more about lease accounting using software programs like EZ Lease, which enables them to value lease assets properly.

Advantages Of Lease Accounting

Leases have many advantages over buying, and a lessee can enjoy the following benefits when they lease:

1. Balanced Cash Outflow

Cash is paid immediately when a business purchases an asset.  A leasing agreement, on the other hand, is a different story. 

The biggest advantage of leasing is that lease payments are spread over a longer period, reducing the burden of large, one-time cash payments. By doing so, a business can maintain a steady cash flow profile.

2. Quality Assets

In leasing, the asset’s ownership remains with the lessor, while the lessee pays only rental expenses. Due to this agreement, businesses can invest in good-quality assets that might otherwise seem unaffordable or expensive. 

Moreover, the preserved cash can also finance other projects or activities.

3. Better Planning

Lessees pay a fixed rental rate each year regardless of the increase in asset cost. 

In an agreement, leasing expenses remain the same over the asset’s lifespan or lease term or increase with inflation. 

A budgeting exercise facilitates the planning of expenses and cash outflows, giving businesses more flexibility than purchasing.

4. Low Capital Expenditure

For newly established businesses, buying assets is not a good idea. Leasing is an ideal option for surviving in a competitive market. 

The benefits of leasing include lower costs and capital expenditures, which allow businesses to spend more on advertising and other expenses. 

5. No Risk of Obsolescence

Leasing offers great returns in sectors with high obsolescence risks and eliminates the risk of investing in obsolete equipment that might soon become obsolete.  For example, it’s especially suitable for technology businesses, where investing in the wrong asset can result in huge losses.

6. Convenience

A major advantage of leasing is that there are fewer formalities than when borrowing money.

When it comes to financing fixed assets, leasing is the most convenient option. You do not need a mortgage or a security deposit. As a result, many restrictions associated with traditional long-term loans from lending institutions are eliminated. 

7. Hidden liability

The fact that a lease is an off-balance sheet item is one of the most notable benefits of lease accounting. On the company’s balance sheet, payments for financing the leased asset are not recorded as liabilities. In contrast, loans raised for the purchase of fixed assets are reported as liabilities. This helps the lessee report a lower debt-to-equity ratio.

8. Termination Rights

It is possible for the lessee to purchase the property at the end of the lease period and terminate the lease contract, which provides the business with flexibility.

9. Benefits of Taxes

Tax benefits are available to both parties, i.e., lessor and lessee. 

The lessor can claim depreciation as an expense in his books since he is the asset owner. On the other hand, a lessee can claim monthly lease payments as expenses and benefit from them.

10. Avoiding ownership and its risks

Because leasing entails no ownership, money cannot be invested into the asset. As a result, the business has more opportunities to borrow money as leverage remains low.

11. Maintenance and Specialized Services

Depending on the lease arrangement, the lessee may be able to obtain specialized maintenance services from the lessor. Although leasing companies charge higher rents for these services, their specialized services reduce overall administrative and service costs.

Conclusion

The business must consider various factors when deciding whether leasing is right for them. Changing accounting standards poses significant challenges and substantial burdens for lease accounting.

However, these standards simultaneously provide an opportunity to integrate processes and tools so that all stakeholders understand how lease agreements and contracts affect their organizations.

It is possible to remove those burdens and enjoy the benefits by using a lease accounting system that automates the process and offers a more efficient way to manage leases, allowing business leaders to focus on the unique pros and cons of leasing for their company.

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