GAAP Lease Accounting: Practical Problems and Solutions

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Although the new GAAP lease accounting rules only became mandatory for non-public companies in 2022, the current standards originated in an FASB proposal almost seven years ago and public companies have been grappling with them since 2019. As with most new accounting standards, unanticipated issues have arisen and some questions are still unanswered.

 In this course we will cover the following topics:

  • Determining Initial Direct Costs Under a Narrower Standard 
  • The Sometimes Confusing Definitions Applicable to the New Standard
  • Properly Determining Lease Components
  • Dealing with Subleases
  • Handling Variable Lease Payments
  • Leases Acquired in the Purchase of a Business
  • Sales-Leaseback Accounting
  • Lease Accounting with Build-to-Suit Arrangements
  1. Introduction
  2. Topics Covered 00:02:54
  3. Basics Refresher 00:03:35
  4. Calculating ROU Asset 00:03:49
  5. Finance vs. Operating Leases 00:06:32
  6. Financing Lease Criteria 00:10:18
  7. Adopting New Rules Example 00:14:15
  8. Initial Direct Costs 00:16:09
  9. Initial Direct Costs & ROU Asset 00:16:17
  10. Initial Direct Costs - Incremental Costs 00:17:48
  11. Initial Direct Costs - ROU Asset And Lease Liability 00:21:36
  12. Practical Expedient Info 00:21:35
  13. Definitions 00:22:39
  14. Lease Definition 00:22:53
  15. Definition of Contract 00:25:47
  16. Definition of Control 00:27:38
  17. Identifiable Property 00:28:09
  18. Is an Easement a Lease? 00:39:32
  19. Inception vs. Commencement Date 00:31:18
  20. Inception vs. Commencement Date Cont’d 00:31:51
  21. Lease Term 00:33:20
  22. Lease Payments 00:33:45
  23. Lease Components 00:38:12
  24. What is a Contract Component? 00:38:27
  25. Lease vs. Nonlease Components 00:39:49
  26. Criteria for Lease Components 00:40:24
  27. Example 00:42:24
  28. Example Cont’d 00:42:53
  29. Nonlease Components 00:44:12
  30. Makeup of Total Consideration 00:47:15
  31. Makeup of Total Consideration Cont’d 00:47:25
  32. Taxes and Insurance (Fixed) 00:48:09
  33. Taxes and Insurance (Actual) 00:50:09
  34. Lessee Allocation Summary 00:51:39
  35. Lessor Allocation Summary 00:53:20
  36. Summary of Steps 00:53:26
  37. Subleases 00:54:13
  38. Lessor/Lessee/Sublessee 00:54:29:
  39. Finance or Operating Sublease? 00:56:15
  40. Effect of Sublease on Lessor 00:58:32
  41. Effect of Sublease on Lessee 01:00:48
  42. Effect of Sublease on Lessee Cont’d 01:02:11
  43. Effect of Sublease on Lessee Cont’d 01:02:15
  44. Effect of Sublease on Sublessee 01:03:04
  45. Variable Lease Payments 01:04:08
  46. Acquired Leases 01:04:26
  47. Sale-Leaseback Accounting 01:05:42
  48. Structure of Transaction 01:08:26
  49. Sale-Leaseback Definition 01:09:55
  50. Benefits of Sale-Leaseback: Seller 01:12:14
  51. Benefits of Sale-Leaseback: Buyer 01:13:40
  52. Example 01:15:22
  53. Accounting for Sale-Leaseback 01:118:18
  54. Example: Year 1 01:20:13
  55. Operating Lease Example: Year 1 01:20:49
  56. Operating Lease Example: Year 1 01:22:34
  57. Amortization by Seller/Lessee 01:23:09
  58. Only for Operating Leases 01:24:16
  59. Structure if Leaseback is Finance 01:26:01
  60. Application to Options 01:26:57
  61. Diagram of Option Transaction 01:29:10
  62. Lease-In Lease-Out (LILOs) 01:33:34
  63. Build-To-Suit Arrangements 01:35:46
  64. Lease 01:36:17
  65. Build-To-Suit 01:37:22
  66. Basics of Build-To-Suit 01:38:07
  67. Definition of Control 01:39:04
  68. Accounting for Build-To-Suit 01:39:31
  69. Thank you 01:42:32

  • Chuck Borek

    Chuck Borek

    Chuck Borek is a practicing attorney and founder of  the Borek Group, LLC. Chuck is also a CPA, and his background includes  five years as a partner in a public accounting firm. He received his law degree and MBA summa cum laude from the University of Baltimore in 1993, where he was editor [...]

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  • Amortization 01:22:41
  • Asset 00:10:27, 00:27:48, 00:38:03, 00:44:16, 01:10:08, 01:18:55, 01:26:13
  • Balance Sheet 00:03:52, 00:08:59, 00:09:57, 00:20:29, 01:02:29
  • Build-To-Suit Lease 00:03:26, 01:38:07
  • Contract 00:23:05, 00:27:17, 00:38:25, 01:10:00
  • Cost 00:06:10, 00:40:00, 00:44:39
  • Direct Costs 00:03:12, 00:16:11, 00:16:39, 00:17:52
  • Fair Market Value (FMV) 00:31:35, 01:15:31
  • FASB - Financial Accounting Standards Board 00:
  • Finance Lease 00:08:28, 00:14:09, 00:56:23
  • Generally Accepted Accounting Principles (GAAP) 00:01:39, 00:21:57, 00:31:43, 01:38:13
  • Implicit Rate 00:05:26
  • Lease Liability 00:06:21, 00:16:31, 01:21:16
  • Lessee 00:04:08, 00:36:41, 00:42:35, 00:58:35, 01:38:16
  • Lessor 00:05:26, 00:14:07, 00:38:02, 00:39:03, 00:42:28, 00:58:46
  • Operating Lease 00:08:28, 00:09:32, 00:56:24, 01:00:52, 01:24:18
  • Present Value (PV) 00:05:15, 00:10:00, 00:20:12, 00:56:44
  • Right-of-Use Asset (ROU Asset) 00:03:48, 00:04:17, 00:05:58, 00:09:56, 00:16:19, 00:19:55, 00:56:34, 01:18:59, 01:21:11
  • Sale and Leaseback 00:03:22, 01:05:46, 01:25:00
  • Sublease 00:03:17, 00:54:15, 01:00:52
  • Total Cost 01:20:16
  • Transaction 00:07:37, 01:00:04, 01:35:56

Amortization: An accounting term that refers to the process of allocating the cost of an intangible asset over a period of time. It also refers to the repayment of loan principal over time. (investinganswers.com)

Asset: Property owned by a person or company, regarded as having value and available to meet debts, commitments or legacies.

Balance Sheet (BS): A financial report that summarizes a company's assets (what it owns), liabilities (what it owes) and owner or shareholder equity at a given time.

Build-To-Suit Lease: Build-to-suit leases are unique real estate contracts that allow business owners to develop commercial properties that perfectly suit their needs. In exchange, they lease the completed property from the developer who built the real estate, paying them rent over 10 to 20 years.

Contract: A written or spoken agreement, especially one concerning employment, sales, or tenancy, that is intended to be enforceable by law.

Cost: The sum of the applicable expenditures and charges directly or indirectly incurred in bringing an article to its existing condition and location

Direct Costs: Direct costs are expenses that directly go into producing goods or providing services, while indirect costs are general business expenses that keep you operating. Examples of direct costs are direct labor, direct materials, commissions, piece-rate wages, and manufacturing supplies.

Fair Market Value (FMV): The term fair market value is used throughout the Internal Revenue Code among other federal statutory laws in the USA including Bankruptcy, many state laws, and several regulatory bodies. In litigation in many jurisdictions in the United States, the fair market value is determined at a hearing.

Finance Lease: A financial lease is generally treated like loan. Here, asset ownership is considered by the lessee, so the asset appears on the balance sheet.

Generally Accepted Accounting Principles (GAAP): A set of rules and guidelines developed by the accounting industry for companies to follow when reporting financial data. Following these rules is especially critical for all publicly traded companies.

Implicit Rate: The rate implicit in the lease is the interest rate set by the lessor in the lease agreement. This is the rate at which the present value of the lease payments and the unguaranteed residual value equals the sum of the fair value of the underlying asset and any initial direct costs of the lessor. To calculate the implicit rate, find the percentage that, when applied to the sum of the minimum lease payments, causes the present value of all the payments to equal the current fair market price of the rental property. On a computer spreadsheet, type =RATE(in a cell).

Lease Liability: In accounting, a lease liability is a financial obligation to make the payments arising from a lease, measured on a discounted basis. Lease liability is calculated using the present value of the lease payments over the lease term discounted, typically, using the lessee's incremental borrowing rate.

Lessee: In a lease agreement, the lessee is defined as the party that pays for the use of the asset or property.

Lessor: One that transfers property (such as a house or a car) by a contract. The lessor is the party that receives payments from the lessee in exchange for the usage of its asset or property.

Operating Lease: An operating lease is generally treated like renting. That means the lease payments are treated as operating expenses and the asset does not show on the balance sheet.

Present Value (PV): The current value of a future sum of money based on a specific rate of return. Present value helps us understand how receiving $100 now is worth more than receiving $100 a year from now, as money in hand now has the ability to be invested at a higher rate of return. See an example of the time value of money here.

Right-of-Use Asset (ROU Asset): In accounting, the right-of-use asset (ROU asset) arises from a lease agreement and represents the lessee's license to hold, operate, or occupy the leased property or item over the lease term. The asset is calculated as the initial amount of the lease liability, plus any lease payments made to the lessor before the lease commencement date, plus any initial direct costs incurred, minus any lease incentives received.

Sale and Leaseback: A "sale/leaseback" or "sale and leaseback" is a transaction in which the owner of a property sells an asset, typically real estate, and then leases it back from the buyer. In this way, the transaction functions as a loan, with payments taking the form of rent.

Sublease: A sublease is a lease by the lessee of an estate to a third person, conveying all or part of the estate for a shorter term than that for which the lessee holds originally. A sublease is a new contract between the lessee and the sublessee. The original lessee turns into a sublessor in this new contract.

Total Cost: Total cost is the total expenditure incurred to produce some type of output. From an accounting perspective, the total cost concept is more applicable to financial reporting, where overhead costs must be assigned to certain assets.

Transaction: In QuickBooks, a transaction type identifies what kind of transaction occurred, such as a customer transaction, bill payment or a bank transfer. When you submit a transaction, you type in a transaction code to represent it.

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Frequently Asked Questions

Under ASC 842, initial direct costs are incremental costs of a lease that would not have been incurred had the lease not been obtained—typically limited to payments made to third parties such as brokers or external legal fees directly tied to executing the lease. Under the narrower standard compared to prior guidance, many costs previously capitalized (such as internal costs or salesperson commissions) are no longer eligible. Qualifying initial direct costs are added to the ROU asset at lease commencement, effectively increasing the carrying value on the balance sheet and impacting amortization over the lease term. Incorrectly including non-qualifying costs inflates the ROU asset and misstates the balance sheet. Organizations should establish clear capitalization policies defining which lease-related costs qualify as initial direct costs, document them thoroughly at the time of lease execution, and ensure accounting teams apply the narrower ASC 842 standard consistently.
When a lessee subleases leased property to a third party, the original lessee becomes both a lessee (under the head lease) and a lessor (under the sublease), requiring separate accounting for each arrangement. For the head lease, the original lessee continues recognizing the ROU asset and lease liability as before. For the sublease, the lessee-turned-sublessor must classify the sublease as either an operating or finance lease based on the sublease terms relative to the remaining head lease term. If the sublease is classified as a finance lease, the sublessor derecognizes the head lease ROU asset and recognizes a net investment in the sublease. If classified as an operating lease, the original ROU asset remains on the balance sheet while sublease income is recognized straight-line. Companies with significant real estate footprints who sublet excess space must carefully evaluate each sublease arrangement to determine proper classification and presentation under ASC 842.
Variable lease payments—those that depend on an index, rate, usage, or other variable factor—receive different treatment under ASC 842 depending on their nature. Payments that vary based on an index or rate (such as CPI-linked rent escalations) are included in the lease liability measurement at the commencement date using the index or rate at that date. When the index or rate changes, the lease liability must be remeasured. However, variable payments based on actual usage, performance, or other non-index/rate factors (such as utilities or common area maintenance charges) are excluded from the lease liability and expensed as incurred. This distinction significantly affects the size of the recognized lease liability and ROU asset. Careful contract analysis is required to properly segregate lease components from nonlease components and accurately classify each payment type, as errors in this determination can materially misstate balance sheet liabilities.
A sale-leaseback transaction occurs when an entity sells an asset and simultaneously leases it back from the buyer, often used to unlock equity while retaining operational use of the asset. Under ASC 842 and ASC 606, the transaction must first pass a true sale test—the transfer of the asset must qualify as a sale under ASC 606's revenue recognition framework. If it qualifies as a sale, the seller-lessee derecognizes the asset, recognizes any gain or loss on the sale, and records the leaseback under ASC 842's standard operating or finance lease framework. If the leaseback is an operating lease, any gain is recognized immediately. If the transaction does not qualify as a sale (e.g., the seller retains a repurchase option), it is treated as a financing arrangement rather than a true sale-leaseback. Understanding the nuances of sale-leaseback accounting is critical for real estate, equipment-heavy industries, and companies seeking off-balance-sheet financing alternatives.
Build-to-suit arrangements are real estate contracts where a developer constructs a facility to a tenant's specifications and then leases the completed property to that tenant. Under ASC 842, the key accounting question is whether the tenant (lessee) controls the underlying asset during the construction period. If the lessee controls the asset being constructed—by having the right to direct construction decisions or having the ability to obtain substantially all economic benefits—it must recognize the construction-period asset on its balance sheet as a financing arrangement. If the lessee does not control the construction-period asset, it simply recognizes the lease upon commencement under normal ASC 842 rules. This control assessment requires careful judgment based on the contractual terms and the nature of any tenant improvements. Build-to-suit accounting can have significant balance sheet implications, particularly for large corporate headquarters, distribution centers, or manufacturing facilities developed under long-term lease commitments.