What Is a Short-Term Lease & Its Accounting Treatment?

Leases are contractual arrangements that grant one party, the lessee, the right to use an asset owned by another party, the lessor, for a specified period. These agreements are fundamental to many businesses, allowing them to access necessary equipment, property, or vehicles without the immediate financial outlay of outright purchase. Within the broader landscape of lease accounting, a specific classification known as a “short-term lease” exists, distinguished by its unique characteristics and simplified financial reporting requirements. Understanding this particular type of lease is important for businesses navigating financial standards.

Defining a Short-Term Lease

A short-term lease is specifically defined under accounting standards, such as ASC 842, primarily by its duration. At the commencement date of the lease, the lease term must be 12 months or less. An additional condition is that the lease must not include an option for the lessee to purchase the underlying asset if the exercise of that option is reasonably certain.

The determination of the lease term involves considering not only the non-cancellable period but also any options to extend or terminate the lease if the lessee is reasonably certain to exercise them. For example, if a 9-month lease includes a renewal option that the lessee is highly likely to take, the lease term might be considered longer than 9 months, potentially disqualifying it as short-term. However, if a 12-month lease is renewed for another 12 months after its expiration, it can be treated as a new, distinct short-term lease. This means a business could theoretically use an asset for multiple years through successive short-term agreements.

Accounting Treatment for Short-Term Leases

The accounting treatment for short-term leases differs significantly from that of longer-term leases under standards like ASC 842. For short-term leases, companies generally do not recognize a Right-of-Use (ROU) asset or a corresponding lease liability on their balance sheets. This contrasts with most other leases, which require balance sheet recognition.

Instead of balance sheet capitalization, the lease payments for short-term leases are typically recognized as an expense in the income statement. This expense is usually recognized on a straight-line basis over the lease term. For instance, if a company pays $1,200 for a 12-month short-term lease, it would recognize $100 of lease expense each month. This simplified approach aims to reduce the administrative burden associated with tracking and reporting numerous short-duration leases.

The Short-Term Lease Election and its Implications

Under standards like ASC 842, businesses can elect an accounting policy not to recognize ROU assets and lease liabilities for short-term leases on their balance sheet. This decision is generally applied by class of underlying asset, meaning a company might choose this simplified treatment for all its office equipment leases but not for its real estate leases.

This election primarily reduces administrative burden by eliminating the need to calculate and track ROU assets and lease liabilities for numerous short-duration arrangements. Electing this option means that lease liabilities do not appear on the balance sheet, which can affect certain financial ratios, such as debt-to-equity. Companies are still required to disclose information about their short-term lease expense in the notes to their financial statements.