Lease accounting is strange. I remember back pre-lease accounting when we heard for 20 years about THIS being the year FASB might get lease accounting done for GAAP. Before that, there were operating leases and financing leases. Operating was essentially a normal lease of equipment with no balance sheet impacts, and a financing one where you lease it for so long or paid back so much of the original asset price that you might as well be considered as having bought the dang thing so you recorded like you did. What ASC 842 did was bring operating leases on the GAAP books like they were financing leases (loosely).
Understand it takes quite a bit to trigger a “financing” lease for tax purposes, ie, one where you can depreciate it for tax. So we are going to assume for this conversation that what you have in hand is not an acquisition of an asset for tax purposes.
For tax, there is no lease liability basis for an ASC 842 lease. There isn’t even an asset to have basis in. Tax is raising its eyebrows skeptically and saying, “Yeah, no. That’s just rent expense.” All the drama belongs to GAAP on this subject.
What the heck IS GAAP doing? Lets look at a GAAP classified financing type lease.
Pretend I enter into an agreement to rent equipment for 5 years at $25k rent expense per year. GAAP looks at the $125k in payments over 5 years and figures out that the present value of that stream of payments is $118k (I’m making up numbers here). The difference is going to be “interest expense”, time value of money. So the first year GAAP entry looks as follows:
Right of Use Asset 118,000
Lease Liability 118,000
Tax is over here rolling its eyes at GAAP.
GAAP has two cumulative entries at the end of the year. The first is the amortization of the ROU Asset (yeah, no, we are totally depreciating this thing like its a REAL fixed asset, but since its a “right” or intangible, its amortization).
Amortization expense 24,000
Accumulated amortization 24,000
Next, we owe rent of $25k for the year. Mix in drama and GAAP records that as:
Interest expense 2,000
Lease Liability 23,000
Cash 25,000
Notice there is no rent expense for GAAP. Its “amortization” of the ROU Asset. Bizarre.
So, at the end of the year we have the following account balances debit (credit) to calculate our DTA/DTL from:
GAAP Tax
Right of Use Asset (net of AA) 94,000 –
Lease Liability (95,000) –
Interest expense 2,000 –
Amortization expense 24,000 –
Rent expense – 25,000
Notice tax has rent expense of $25k, the amount of cash paid for rent.
If this was all the activity in the entity during the year, the current provision would be as follows:
Pretax GAAP loss (26,000)
ROU Present Year (94,000)
ROU Prior Year –
Lease Liability Present Year 95,000
Lease Liability Prior Year –
Tax loss (25,000)
Be aware of a major pitfall, though.
This ROU Asset is likely on the schedule of fixed assets. The amortization expense may even been mixed in with other amortization expense, or even recorded in one joint depreciation/amortization expense account.
Now, best practice is to take a balance sheet approach and compare the tax and GAAP basis of balance sheet accounts, but some tax preparers stick to an income statement approach. If an income statement approach is taken, and amortization of ROU is mixed in with other fixed asset amortization then you might have a bit of a headache. (I personally never rely on income statement approach, as you need to tie out each and every DTA/DTL to ending detailed support, so you might as well have basis rollforwards for each DTA/DTL.)
That example above was for a financing lease. An operating lease is similar except that GAAP will not book to amortization and interest expense, it will book to “lease expense”, or essentially rent expense, in order to reduce the ROU Asset. There is still an amortization schedule that has implied interest expense in it, the name of the income statement account is just different.
The last lease type is a sales back lease. It’s very similar in treatment to a financing lease. This is the lease most likely to be an actual asset sale for tax. Now that you know the basics for leases, this one you can figure out on your own.
Tax Sophomore 