Lease Treatments: Non-Deferred Rent Treatment

Some of the most asked questions about the Asset Leasing module are often answered by navigating to lease classification test tab of the lease book. The lease classifications drive how a lease behaves: from the calculation of the depreciation expense to whether an initial recognition journal entry is needed.

This blog post will dive deeper into those leases not classified as deferred rent treatment and are therefore recognized on your balance sheet.

Non-Deferred Rent Treatment Leases

When a lease is not classified as deferred rent treatment, the module will generate a liability amortization schedule and if the lease is not associated to a fixed asset, an asset depreciation schedule. The user will also post an initial recognition journal entry to recognize the lease liability and right-of-use asset:

However, not all non-deferred rent treatment leases are created equally. The major difference lies within the asset depreciation schedules. Let’s take a deeper look at each lease type and how the Asset Leasing module will depreciate the lease asset when not tied to a fixed asset.

Finance Leases

When a lease is classified as a finance lease, the asset depreciation schedule created through the Asset Leasing module, will be straight-lined. In other words, the monthly depreciation expense is calculated as the initial right-of-use asset divided by the lesser of the lease term or asset useful life for each month of the lease. This produces one depreciation expense amount every month to uniformly depreciate the right-of-use asset:

Operating Leases

When a lease is classified as an operating lease, the lease asset depreciation expense calculation is more complex than a simple straight-line calculation. The depreciation expense is essentially a “plug” figure to ensure the lease produces the same amount of expense, interest and depreciation, on a monthly basis. Therefore, the depreciation expense amount is likely to vary period to period.

The module will first calculate the total lease cost which is the sum of lease payments plus the difference of the lease asset and the lease liability.

To find the monthly lease cost, the total lease cost is simply divided by the number of depreciable periods which is the lesser of the lease term of asset’s useful life. This monthly lease cost is the amount of expense expected to be recognized every month between interest expense and depreciation expense.

The interest expense for the same month is subtracted from this monthly lease cost to find the depreciation expense. You can see how this value is essentially a “plug” to ensure the same monthly lease cost will hit the P&L each month:

Operating Lease Example

This concept is best understood when visualized. Assume an operating lease with the following facts:

• Incremental borrowing rate: 5%
• Asset useful life: 360 months
• Annuity type: Annuity due
• Compounding interval: Monthly
• Initial direct costs: $100
• Commencement date: 1/1/2020
• Payment schedule lines:
  • 12 months of $1,000 paid monthly
  • 12 months of $1,500 paid monthly

Total lease payments total $30,000 and the initial lease liability is $28,468.33:

The initial right-of-use asset is calculated as $28,568.33 which is the present value of lease payments plus the $100 of initial direct costs:

The first month of interest expense was calculated as $114.45 using the effective interest method:

The depreciable base is 24 months because the lease term is less than the asset’s useful life of 360 months. With this information, we can calculate the 1^st month’s depreciation expense: 

You will notice how the total expense for each month is calculated as $1,254.17:

Lease Types and Posting Parameters

On a final note, it is important to understand how the lease classifications drive the accounts used in each journal entry. In the Asset Leasing parameters, the user can configure the accounts to be used for each posting type. These accounts are bifurcated between finance main accounts and operating main accounts:

The module will use either the finance or operating main accounts corresponding with the lease type for that lease book. Therefore, if you want to troubleshoot the accounts the Asset Leasing module is using, I would again recommend viewing the Lease Classifications Test tab to determine the lease type before viewing the Asset Leasing parameters.

Final Thoughts

It is important to understand the key differences between a finance and operating lease in the Asset Leasing module. Especially for operating leases, the depreciation schedule is not intuitive and may be difficult to recalculate without prior knowledge of the US GAAP ASC 842 standard. Understanding the nature of operating and finance leases is key for configuring the Asset Leasing module and for your lease portfolio.

By Brian Markgraf CPA, Crowe, a Microsoft Dynamics 365 Gold Partner https://www.crowe.com/services/consulting/microsoft-dynamics-365

Learn more about Crowe’s Microsoft Asset Leasing Quick Start Implementation here.