Lease Liability and ROU Asset Presentation on the Financial Statements. CPA Exam FAR

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In this video, we discuss lease liabilities and ROU assets presentation on the financial statements.
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On a balance sheet, ROU assets and their matching lease liabilities can be shown in two main ways: as individual line items in the appropriate sections or combined with other similar items, with detailed disclosures provided in the notes to the financial statements, indicating their inclusion in specific balance sheet categories. Lease liabilities that are due within the forthcoming year or the business's operating cycle, if it's longer, are to be listed as current liabilities, with the remaining balance classified under long-term liabilities. It's crucial to separate the presentation of finance and operating lease-related ROU assets and liabilities; they should not be consolidated. The value of the ROU asset diminishes over time through amortization, while the associated lease liability decreases as lease payments are made.
The depreciation of the ROU asset begins on the start date of the lease, and the straight-line method is generally used for this purpose, except in cases where an alternative approach better captures how the asset is used and consumed over time.
When deciding on the amortization duration, consider these points:
If the lease agreement results in the lessee owning the asset at the end of the lease or includes a purchase option that is likely to be used (reflecting ownership intentions or options), the amortization period should extend over the asset's expected lifespan.
If the lease's present value is a significant portion of the asset's total value, if the lease duration encompasses most of the asset's economic life, or if the asset is so specialized that it would not be useful to anyone else after the lease (indicating value, life expectancy, or specificity considerations), then the ROU asset should be amortized over whichever is shorter: the lease's duration or the asset's estimated useful life.
For operating leases, the total cost of the lease is reported as a lease expense within the income from continuing operations section of the income statement. This approach spreads the lease cost evenly across the lease period, showcasing it as a regular operational expense.
For finance leases, however, the expense recognition on the income statement is bifurcated. One component is the amortization of the ROU asset, indicating the leased asset's diminishing value over time and included in operating expenses. The other component is the interest expense related to the lease liability, capturing the financing cost and listed under financial expenses. This method separately accounts for the asset's depreciation and the finance charge, offering a more detailed view of the lease's financial impact.
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