Lease Disclosure Requirements in Financial Statements

Lease disclosures are the details companies provide in their financial statements to explain their leasing activities. The goal of these disclosures is to offer a clear picture of the amount, timing, and uncertainty of cash flows related to leases. This transparency allows stakeholders to better assess a company’s financial obligations and the assets it controls through leasing arrangements.

Recent accounting standards have altered how companies report leases. Previously, many lease obligations were kept off the main financial statements, a practice known as off-balance sheet financing, which made it difficult to see a company’s true financial position. New regulations, such as the Financial Accounting Standards Board’s (FASB) ASC 842, now require most leases to be recognized on the balance sheet, increasing the extent of the related disclosures.

This shift to on-balance sheet recognition means companies must provide both quantitative (numerical) and qualitative (descriptive) information in the footnotes of their financial statements. This combination helps users understand the numbers and the context behind them. The disclosures cover the general nature of a company’s leases and the specific judgments made in calculating lease values, allowing for a more complete analysis of leasing commitments.

The Balance Sheet Presentation of Leases

For companies that lease assets (lessees), accounting standards require presenting most leases on the balance sheet. This is accomplished by recognizing a Right-of-Use (ROU) asset and a corresponding Lease Liability. The ROU asset represents the lessee’s right to use the leased item for the lease term, while the lease liability represents the financial obligation to make payments.

The initial value of both the ROU asset and the lease liability is determined by calculating the present value of all future lease payments using a specific interest rate. The ROU asset also includes any initial direct costs incurred by the lessee and any lease payments made before the lease begins, minus any lease incentives received from the asset owner (the lessor).

Leases are classified by the lessee as either a finance lease or an operating lease. A finance lease is economically similar to purchasing the asset with financing, where the risks and rewards of ownership are transferred to the lessee. An operating lease is any lease that does not meet the criteria for a finance lease and is more akin to a simple rental.

The on-balance sheet presentation differs slightly between the two classifications. For a finance lease, the ROU asset and lease liability are presented separately from other assets and liabilities or are disclosed in the footnotes. For an operating lease, the ROU asset and lease liability are also on the balance sheet, often included within other line items, with the specific amounts detailed in the footnotes.

Required Qualitative Disclosures for Lessees

Beyond the numbers on the balance sheet, companies must provide descriptive, or qualitative, disclosures in their financial statement footnotes. This narrative information gives context to the leasing figures and helps users understand the nature and extent of a company’s leasing activities, commitments, and associated risks.

A primary disclosure is a general description of the company’s leases. This includes the types of assets the company leases, which commonly include real estate for offices or retail space, fleets of vehicles, and specialized equipment for manufacturing or operations.

Companies must also provide information about terms and conditions within their lease agreements. This involves explaining the basis for how any variable lease payments are determined, such as payments tied to a percentage of sales or an index. It also requires detailing the existence of options to extend or terminate leases, as well as any purchase options.

Another area for disclosure involves the judgments and assumptions made when applying the lease accounting standard. Companies must explain how they determined the discount rate used to calculate the present value of lease payments. They also need to describe the judgments used in determining the lease term, especially when leases contain extension or termination options that are reasonably certain to be exercised.

Companies must disclose information about leases that have not yet commenced but that create significant rights and obligations for the entity. The disclosures also cover any restrictions or covenants imposed by lease agreements, such as limitations on paying dividends or taking on additional debt.

Required Quantitative Disclosures for Lessees

Lessees must provide specific numerical data in the footnotes, including a maturity analysis of lease liabilities. This analysis must show the undiscounted cash flows the company is obligated to pay for each of the first five years, and a single total amount for all the years thereafter.

For example, a maturity analysis table would look something like this:
| Year | Undiscounted Lease Payments |
| :— | :— |
| 2025 | $1,200,000 |
| 2026 | $1,150,000 |
| 2027 | $1,100,000 |
| 2028 | $1,000,000 |
| 2029 | $950,000 |
| Thereafter | $4,500,000 |
| Total Undiscounted Payments | $9,900,000 |

Following the maturity analysis, a company must provide a reconciliation of these undiscounted cash flows to the discounted lease liability recorded on the balance sheet. The difference between the total undiscounted payments and the balance sheet liability represents the amount of imputed interest embedded in the future payments. This reconciliation helps connect future cash commitments to the present value recognized in the financial statements.

Companies are also required to disclose the total lease cost for the period, broken down between finance and operating leases. For operating leases, this is a single, straight-line expense, while for finance leases, it is separated into the amortization of the ROU asset and the interest on the lease liability. Detail on variable and short-term lease costs must also be provided.

Two other metrics that must be disclosed are the weighted-average remaining lease term and the weighted-average discount rate. The weighted-average remaining lease term gives an idea of the average time horizon over which the company’s lease obligations will be settled. The weighted-average discount rate provides insight into the average interest rate the company used to calculate its lease liabilities.

Quantitative disclosures must include information about cash flows and non-cash activities. This includes the cash paid for amounts included in the measurement of lease liabilities. Companies must also report non-cash information, such as ROU assets obtained in exchange for new lease liabilities, showing leasing activity that did not involve an initial cash outlay.

Disclosure Requirements for Lessors

The disclosure requirements also extend to the lessor, the entity that owns an asset and leases it to another party. These disclosures provide insight into a lessor’s business model, its reliance on lease income, and how it manages the risks associated with owning and leasing assets.

Lessors must provide a general description of their leasing arrangements, including the types of assets they lease out and the general terms of their lease contracts. This narrative provides context for the quantitative information presented in the footnotes.

A quantitative disclosure for lessors is the lease income recognized during the period, which must be presented in a table and broken down by type. For operating leases, this is rental income. For sales-type and direct financing leases, it includes any profit or loss recognized at lease commencement and the interest income earned over the lease term.

Lessors that engage in sales-type or direct financing leases must disclose their net investment in these leases. This net investment is presented separately on the balance sheet and is composed of the lease receivable and the lessor’s unguaranteed residual asset. The unguaranteed residual asset is the estimated value of the leased asset at the end of the lease term. Lessors must also provide a maturity analysis for their lease receivables.

A disclosure for lessors is information about how they manage the risk associated with the residual value of their leased assets. This is the risk that the asset’s value at the end of the lease will be lower than anticipated. The disclosure should describe the lessor’s strategies for mitigating this risk, such as using third-party insurance or carefully selecting lessees.