Here are the criteria for recognizing operating leases in the balance sheet

Is the lease in practice an investment? If the lease fulfills 1 of 4 criteria, it will probably be recognized in the balance sheet.

Does your company fulfill two or three of the following criteria?

1. At least 50 employees
2. At least NOK 70 million in sales
3. At least NOK 50 million in balance sheet assets

If so, you should be particularly aware of the requirements that apply in all three Scandinavian countries for recognizing finance leases in the balance sheet, which are in accordance with the rules laid out in the international standard IAS 17.

Finance leases are contracts where the lessee bears the majority of the financial risk as well as control of the operating asset that is leased. These will be recognized in the lessee’s balance sheet because in reality a transaction has occurred that can be compared with a purchase or an investment.

The amounts recognized as assets in the balance sheet represent the economic benefits resulting from the control the lessee has over the items. The lessor retains the formal right of ownership.

Fulfilling 1 of 4 criteria is sufficient

An overall evaluation of the contract must be conducted if there is doubt as to whether the lease is a finance or operating lease. PwC in Norway writes in its guidance to the year-end financial statements that a contract shall be considered a finance lease if at least one of the following criteria is met:

1. It is reasonably certain that the lessee will purchase the property following the expiry of the lease term, as they have the right to purchase the property at a price that is considered to be significantly lower than its market value.
   
   
2. The term of the lease is broadly the same as the asset’s economic life.
   
   
3. The present value of the lease payments essentially correspond to the market value of the asset upon signing the contract.
   
   
4. The particular nature of the asset is such that it cannot be used by anyone other than the lessee without considerable changes or modifications.

Furthermore, PwC writes that the majority of leases for production machinery, heavy transport equipment, and similar, are finance leases. “However, rental contracts for passenger cars are normally operating leases, unless a low buy-back price of the car has been deliberately agreed, in which case the contract is affected by criterion no. 1.”

Keep track of all your lease payments

How many finance leases do you have? It can be challenging enough to maintain an overview of all your contracts, the associated terms and conditions, renewal dates and internal contacts. In addition, some major leasing contracts must be treated in the accounts as if they were investments.

How are the contracts to be treated from one year to the next? It is tough to start from scratch every year, or to have to update spreadsheets. It certainly makes sense to use tools to make the job easier. These will also provide help with calculations for the financial statements, notifications before the contracts expire, where the contracts are saved – and many other useful functions.

House of Control has developed a module that provides complete control of your company’s finance leases, with many of the same properties as the IFRS 16 lease accounting software.