What is an Operating Lease
Commonly Operating leases are found in the supply of office equipment such as photocopiers, fax machines etc. However Operating Leases could exist for other types of assets. It usually involves the lessee paying a rental for the hire of an asset for a period of time that is normally substantially less than its useful economic life. In any lease arrangement it is an operating lease if it is NOT a finance lease. A finance lease is a funding structure for an asset in which the lease transfers substantially all the risks and rewards of ownership to the lessee. It usually involves payment to the lessor the full cost of the asset together with a return on the finance provided by the lessor. So if it is not a finance lease, it is an operating lease. Finance leases are commonly found in the financing of specific assets for a business, such as a machine for production. If you are unsure as to what lease type you are considering consult your advisor.
What is the significance of a lease type
The accounting for an operating lease is different from that of a finance lease. For a finance lease, the capital value of the lease is treated as a fixed asset. The liability to pay the lessor is shown as a creditor. The financing (interest) is charged to the Profit and Loss account on a regular basis. It can be complex and you are advised to agree with your accounting advisor the accounting entries.
For operating leases no fixed asset or creditor accounting is required. (There is however an obligation to make certain disclosures in the statutory accounts of companies and limited liability partnerships). The rentals under an operating lease should be charged on a straight-line basis over the lease term, even if actual payments are made on a different basis. For example if there is a rental holiday for the first three months (although the asset is in use during these three months) of a five year lease, the total rentals should be charged to profit and loss over the period in which the asset is in use. The system has specific functionality to properly deal with operating leases.
Initiating an Operating Lease
The operating lease register is initiated by ticking the Use Operating Lease Register box on the Optional Features tab of the Profile.
Control - Organisation Profile - Optional Features tab
An Operating Lease Register sub-menu is now visible under the Expenses menu.
Expenses - Operating Leases
Setting up an Operating Lease in summary
- Ensure you have the details of the lease arrangements.
- Add the details of the Lease to the lease maintenance screen (see below)
- Make the lease payments to the Lessor.
- The system will run a batch update for operating lease accounting either monthly or annually depending selected charging schedule.
- If required a manual batch run can be selected.
- If the operating lease charge is to be allocated to a particular branch or fund, then ensure that the relevant branches or funds are set up.
An operating lease needs to be dealt with in two stages. The first stage is to set up the details of the lease to allow the system to calculate the appropriate charge to the expense account. (See Adding an Operating Lease below). The second is to deal with the request for payment from the lessor such as an invoice. (See Making Operating Lease Payments below)
Adding an Operating Lease
Make sure the following details are available
- Lease Inception date - When the lease starts
- Lease Termination date - When the lease finishes
- First Payment Date - The first lease payment date
- Payment Period - Monthly, Quarterly, Annual or single payment
- Payment Amount - the regular amount to be paid
- Payment Count - The number of payments to be made over the lease term
Details of leases are entered in the lease maintenance screen that is accessed via the Add-Ins menu.
Add-Ins - Operating Leases - Add Lease
Lease details are entered in the lease maintenance screen, The Lease Name is a unique name for the lease. A Description may be added as necessary.
In the case of a commercial entity, select the Statutory Reporting Area from the list. (If unsure seek advice from your advisor). Select the relevant Branch from the drop down list, if branch analysis of the operating lease charge is required.
For a Not-for-Profit entity there will be a Fund selection available and if activated an Activities selection. It is mandatory to select a Fund.
The allocation to a branch or fund takes place from the next operating lease batch run and does not allocate the cumulative lease charge, only the lease amount for that period and subsequent periods. If it is necessary to have the allocation from a prior date, it may be possible to roll back operating lease batch runs and re-run to current date.
Enter the Lease Inception Date and the Lease Termination Date in the next two fields. This information will be available from the operating lease agreement documentation.
Enter the date of the first payment on the lease in First Payment Date. This information will also be on the lease documentation. Select the payment period from the drop down list in Regular Payment Period; enter the payment amount in the Regular Payment Amount. Enter the number of payments that will be made under the terms of the lease in Regular Payment Count. These elements of data will be shown in the lease documentation. The system will calculate the total cost of the lease and display in the Total Cost field.
Confirm and record the data by clicking on the SUBMIT button.
If the charge schedule that was selected for the entity is Month End, then the system will charge each month to the Operating Lease expense account the appropriate monthly amount and create a liability in the Other Creditors account. If the charge schedule is Annual, it will make the change at the last day of the accounting year.
It is possible to run a batch job that allows the user to select a date up to which lease charging should be calculated and accounted for. See the Batch Jobs for more background. If manual was selected it is up to you to use a journal entry to put in the correct figures.
Making Operating Lease Payments
Operating lease payments to the lessor are made using the usual payment processes as Bills or Payments Bill or Payments may be memorised as with any other transactions.
Expenses - Enter Bill/Credit Note or
Expenses - Payment
The payment account to be selected is Other Creditors (found in the Current Liabilities section of the chart of Accounts).
Terminating a Lease
If a lease is terminated early, select the relevant lease maintenance screen from the list of leases under the Add-Ins Operating Leases menu. Check the termination box. The system will cease any accounting entries immediately. It may well be necessary to make adjusting payments to the Lessor to settle the lease. These adjustments should be entered via the lease journal entry facility.
Reports are available on all transactions relative to a specific lease, groups of leases or all leases. These reports are available via the Reports menu.
Reports - Transaction - Transactions by Lease
Select the relevant leased, group or All, determine the period over which you want the transactions to be shown and click on GENERATE to prepare the report.