Guidelines for Classifying Leases

Finance Leases

A lease is classified as a finance lease when the lease meets any of the following criteria at the commencement of the lease:

The lease transfers ownership of the underlying asset to the lessee (your organization) at the end of the lease term.
The lease grants the lessee an option to purchase the underlying asset that you as the lessee are reasonably certain to exercise.
The lease term is for the major part of the remaining economic life of the underlying asset.
The present value of the sum of the lease payments and any residual value guaranteed by the lessee that is not already reflected in the lease equals or exceeds substantially all of the fair value of the underlying asset.
The underlying asset is of such a specialized nature that it is expected to have no alternative use to the lessor at the end of the lease term.

If your lease is a finance lease, you must recognize the following types of expenses separately:

Interest on the lease liability.
Amortization or depreciation of the right-of-use asset.

When you make a lease payment, you are, in effect, making a capital repayment against the lease obligation, in addition to an interest payment. To show this impact on financial statements, you must recognize the interest expense on the due date and add it to the lease liability balance. The lease liability balance is reduced when you make a lease payment to the lessor.

The amortization schedule calculates and stores the interest amount, principal reduction amount, and interest due date for each lease payment included in the lease liability calculation. Interest expense is recognized in the period in which the interest due date falls.

For leases with payment frequencies that are annual, quarterly, or semiannual, interest expense is recognized once per year, quarter, or half year, respectively. If your lease requires monthly provisioning, create a monthly provisioning recurring journal in your general ledger.

Depreciation for finance lease assets is the same as for owned capitalized assets, using standard depreciation rules, such as the depreciation method, convention, and prorate calendar. When you add your leased asset, the depreciation rules, such as the method and life, are defaulted from the category. You can override the defaulted rules, if necessary.

Interest Expense

Run the Calculate Lease Interest and Expense process for each period to recognize the interest expense on the lease liability in your asset books. You can easily run this process from the Depreciation infotile on the Assets page. Note that you cannot close the period without calculating the lease interest expense for all finance lease assets in the book.

The following table shows an example of an accounting entry for interest expense of 175 USD and the reduction in liability for a lease payment of 1000 USD:

Account	Debit Amount (USD)	Credit Amount (USD)
Lease Interest Expense	175
Lease Liability		175
Lease Liability	1,000
Lease Clearing		1,000

For the interest expense account, all segments except for the natural account are populated by default from the depreciation expense account in the asset assignment. The natural account is populated from the category default accounts. The liability account is the active liability account for the asset.

Assets generates lease payment invoices using the lease clearing account as the invoice distribution account, and transfers the lease payment invoices to Oracle Payables. From Payables, run the Import Payables Invoices process using the source Assets to import any lease payment invoices.

The following table shows an example of an accounting entry for an invoice of 10000 USD:

Account	Debit Amount (USD)	Credit Amount (USD)
Lease Clearing	10,000
Supplier Liability		10,000

The supplier liability of 10,000 becomes zero when you make a payment for the lease invoice shown in the example. At the end of the lease term, the net book value of the leased asset and its lease liability becomes zero.

When you execute an asset inquiry, the results show the lease interest expense balances, including the periodic interest amount, year-to-date interest amount, interest adjustment amount, and lease and liability balance.

Operating Leases

Any lease that doesn't meet the criteria to be a finance lease is called an operating lease. If your lease is an operating lease, you must recognize a single lease expense, which is calculated to amortize the total cost of the lease over the lease term on a straight-line basis.

The operating lease expense for each period is calculated as the amortization of the remaining cost of the lease at the beginning of the period over the remaining lease term on a straight-line basis. The remaining cost of the lease is calculated as the net book value of the asset plus the outstanding interest on the lease liability.

Operating leases do not depreciate. When you add an operating lease asset, Assets automatically deselects the Depreciate check box on the Add Asset or Edit Source Line pages. When you run the Calculate Depreciation process, no depreciation is calculated for operating leases.

Interest Expense

Run the Calculate Lease Interest and Expense process to calculate and recognize operating lease expense. Note that you cannot close the period until you calculate operating lease expense for all operating lease assets in the book.

The following table shows an example of accounting entries for operating lease expense and reduction in liability:

Account	Debit Amount (USD)	Credit Amount (USD)	Comments
Operating Lease Expense	1,200		NA
Lease Liability		900	Interest on lease liability
Depreciation Reserve		300	300 = 1,200 - 900
Lease Liability	1,000		Lease payment amount
Lease Clearing		1,000	Lease payment amount

At the end of lease term, the net book value of the leased asset and its lease liability are both zero.

For the operating lease expense account, all segments except the natural account are populated from the depreciation expense account in the asset assignment. The natural account is populated from the category default accounts. The liability account is the active liability account for the asset. The depreciation reserve account is derived using the same logic used for the depreciation accounting for finance lease assets and owned assets.

If any transactions occur after the operating lease expense is recognized for the current period, the recognized lease expense is automatically rolled back. You must rerun the Calculate Lease Interest and Expense process to include the new transactions.

Note: No catch-up operating lease expense is calculated for backdated operating leases. You must manually enter the opening depreciation reserve at the time you add the operating lease right-of-use asset, or later before closing the period in which asset was added.