3. Record Finance Leases Properly
The University is required to record a right-of-use (“ROU”) asset and a lease liability for finance leases at the lease commencement date. Given the complexity of accounting rules for finance leases and the fact that it requires central-only object codes, FAR will prepare and upload the initial journal, establishing the finance lease asset and liability.

• All ROU assets related to finance leases will be recorded as fixed assets in Oracle Fixed Assets with subsequent depreciation being recorded to the GL monthly by Oracle.
• All liabilities related to finance leases will be recorded as Finance Lease Equipment Liability (object code 2793) or Finance Lease Building Liability (object code 2794).
• Lease prepayments and incentives: If lease payments are made, or lease incentives received, prior to the lease commencement, such as the lease inception date, they should be recorded as prepaid rent. This prepaid amount will be reclassified to the lease asset on lease commencement date

4. Ongoing Measurement and Journals for Finance Leases

• Quarterly Journals: FAR will assist in the initial journal entry set-up and template that will be used for the recurring journal entry going forward. On a quarterly basis, the lease liability is reduced using the effective interest method. Each lease payment is allocated between the calculated lease liability amortization and interest expense. Under this method, interest expense decreases and the liability amortization amount increases over time. As part of the quarterly entry, tubs are responsible for updating the payment coding on finance leases to recognize interest expense and to reduce the liability. When preparing the quarterly entry, tubs must utilize the lease amortization schedule provided by FAR at initial setup to determine the quarterly interest expense and liability reduction amounts. Tubs are responsible for preparing and sending these journal entries to FAR for upload because they require the use of central-only object codes. See Appendix B for an example that illustrates the amortization of a lease liability.
• Depreciation of the finance lease asset: The ROU asset is depreciated on a straight-line basis over the lease term, inclusive of extensions, within OFA. If the lease term is greater than the asset’s useful life, it will be amortized over the asset’s useful life. No manual entries are necessary.
• Making lease payments: lease payments are the responsibility of the tub. Ideally, tubs should establish annual purchase orders for their lease obligations and code these payments as “rent expense” in the General Ledger. These payments should follow local payment policies and guidelines for processing and approving payments. Tubs should check that “rent expense” nets to zero for finance leases on an annual basis (after the impact of the quarterly journal entry).
• The tub is responsible for the reconciliation of object codes 2793 (Capital Lease Equipment Liability) and 2794 (Capital Lease Building Liability). If the balances in these accounts are greater than the reconciliation threshold of $1M, the quarterly reconciliations must be kept on file in accordance with the quarterly financial close checklist

C. Operating Leases
Operating leases are recorded as a ROU Asset and a Lease Liability, equal to the present value of the remaining lease payments, discounted using the rate implicit in the lease (or if that rate cannot be readily determined, the lessee’s incremental borrowing rate), and are adjusted annually by FAR (for units with a standalone audit, the unit is responsible for amortizing the ROU asset and annually reducing the lease liability) for all leases with a remaining lease obligation of $100k or more and a remaining term greater than 1 year. Rent expense is recorded on a straight line or cash basis (see thresholds below for distinction) throughout the year without an impact to the asset or liability. Although operating expenses are treated as rental expense by the tub during the year it is important for the tub to retain information on operating leases for its year-end submission to FAR.

Operating leases are recognized on the balance sheet as their own financial statement line items (separate from finance leases) and are remeasured annually, with expenses recognized as rent/lease expense by the tub. This differs from finance leases, which result in depreciation and interest expense once all monthly and quarterly recurring entries are processed. Any lease that does not meet the Finance Lease criteria above is an operating lease.

1. Record Operating Leases Properly
   Generally accepted accounting principles require operating leases to be recorded on the balance sheet as a ROU asset and Lease liability. In practice, tubs should record operating leases as rent expense as described above however operating lease details including lease term, escalating rent payments, rent expense adjustments, initial direct costs, prepayments, lease improvements, and lease incentive information must be included in the tub’s annual submission to FAR as part of the commitment and contingency request at year-end. FAR will use the information provided to record operating leases on the balance sheet to comply with accounting standards.
2. Operating leases must be recorded on a straight-line basis even if the payments vary in amount over the lease term if the impact of the deferral is greater than or equal to a threshold of $500,000 or more annually in one or more of the lease years. Include in the deferred payment calculation are the basic rent amounts plus any other payments required under the lease terms (e.g., a lease non-renewal penalty or other likely payment required by the lessee). For operating leases with straight-line impact under the $500,000 threshold, rent expense recorded may equal the actual amounts paid.

• Escalating Rent Payments: Lease payments that are not of equal amounts but that escalate during the life of the lease should be recognized on a straight-line basis, unless another systematic and rational basis is more representative of the time pattern in which the leased property is physically employed, based on the above threshold. The time value of money and anticipated inflation should not be considered in allocating scheduled rent increases.
• Rent Expense Adjustments: If the actual rent expense is higher or lower than the straight-line basis rent expense, the tub must record adjusting entries for the difference. See Example #3 in Appendix B for an example of the accounting.
• Initial Direct Costs: The sum of lease payments must include commissions paid upon executing the lease, and therefore must be included in the Commitments and Contingencies annual FAR request. All other initial direct costs are expensed as incurred.
• Special Treatment for Leases Involving Land and Land with Buildings
• For leases that include a land element (e.g. a lease of land and a building, or land and integral equipment), the land may be considered a separate lease if separating the land component would have an impact on lease classification. If you believe that land is a significant component of your lease, please contact FAR.

II. Account fo rLeaseholder improvements - Lessee

A. Capital projects involving leased property (both for external leases and inter tub leases) are treated as leasehold improvements and recorded as a “Capital Leasehold Improvement” on the lessee’s balance sheet because leasehold improvements result in a true asset addition. The accounting is the same regardless of whether the lease is a finance or operating lease. The leasehold improvement must be depreciated over the shorter of the standard useful life or the lease term plus extensions. Refer to the Fixed Assets Policy for additional information.

B. If the lease contains a tenant improvement allowance, this will not impact the value of the leasehold improvement (follow the PPE Policy for costs to capitalize). The tenant improvement allowance will be used as the funding source of the project.Please reach out to FAR for assistance with related journal entries.

C. If the lease contains language on leasehold improvements that will be owned by the lessor, please consult with FAR for accounting implications, as it could impact lease classification or trigger a lease modification.

III. Lessor Accounting
A. Understand the Rules for Lessor Accounting
Harvard is the lessor in a lease transaction when leasing property, plant, or equipment to a third party. Leases must be evaluated to determine if they are operating leases, direct financing leases or sales-type leases, which, in turn, determine the appropriate accounting processes. Leases that do not meet the requirements to be a direct financing or sales-type lease are, by default, classified as operating leases.

A lease must be assessed for direct financing or sales-type lease treatment if the following thresholds are met. If these thresholds are NOT met, the lease must be treated as an operating lease:

1. Cumulative receipts over the life of the lease are >$10M, OR
2. Annual lease year cash receipts are >$1M

If the above thresholds are met, the tub must consult with FAR to determine if the lease is a sales-type or direct financing lease.

B. Record Sales-Type and Direct Financing Leases Correctly
A Sales Type Lease exists when it meets the above cash threshold and one of the criterions in section I.B.2 (lessee accounting) is met. If a lease doesn’t meet any of those five criteria (I.B.2.a-e) then two additional criterion below must be evaluated. If both of the additional criterions are met, then the lease is classified as a Direct Financing Lease. If only one or none of the additional two criterions are met, then the lease is classified an operating lease. The two additional criteria are:

1. Whether the sum of the present values of (a) the lease payments, (b) any residual value guarantee not included in the lease payments, and (c) any residual value guaranteed by third parties, either substantially equals or exceeds all of the fair value of the leased asset.
2. Whether it is probable that the lessor will collect the lease payments and the residual value guarantee(s).

 

This evaluation includes performing the assessment of lease payments described in Section I.B.2.d. For this criterion assessment, the lessor should compare the fair value of the asset against the present value of the total fixed and optional payments that are reasonably certain to be paid under the lease.

Please contact Financial Accounting and Reporting for assistance with the lease evaluation, initial setup and ongoing accounting guidance for a lease determined to be a Sales-type or Direct finance lease, or if you have questions about lessor lease classification.

C. Record Lessor Operating Leases Properly
An operating lease where Harvard is the lessor is treated as rental income by the tub.

 

1. Cash vs. straight-line basis: operating leases must be recorded on a straight-line basis even if the receipts vary in amount over the lease term if the impact of the deferral is $500,000 or more on an annual basis. Tubs may elect to apply straight-line accounting for leases below this threshold. Include in rental income the basic rent amounts required under the lease terms plus any other reasonably certain amounts to be collected from the lessee. For operating leases with straight-line impact under these thresholds, rental income recorded may equal the actual amounts received.

• Escalating rent receipts:  lease receipts that are not of equal amounts but that escalate during the life of the lease should be recognized on a straight line basis based on the threshold above, unless another systematic and rational basis is more representative of the time pattern in which the leased property is physically employed.
• Rent income adjustments:  If the actual rent income is higher or lower than the straight-line basis rent income, the tub must record adjusting entries for the difference. Reach out to FAR with questions on proper accounting entries.
• Initial direct costs: These costs are generally limited to commissions paid upon executing the lease and costs paid to existing tenants as an incentive to vacate the leased premises. All other Initial direct costs are expensed as incurred.
• Generally accepted accounting principles do not require lessor operating leases to be recorded on the balance sheet. Tubs should continue to depreciate the leased asset over its useful life and amortize any deferred initial direct costs. If lease payments were received up front, for example at least inception, record as a deposit liability.
• Tenant improvement allowances: Where a school/unit provides a tenant improvement allowance to a lessee, the capital improvement must be evaluated to determine if the University owns the leasehold improvement. If the school/unit retains ownership of the improvement, the improvement has a useful life beyond the lease term, the improvement has a value of $100,000 or more AND the University pays the construction vendor directly, then the capital improvement must be processed through the CAPS system in accordance with the Property, Plant and Equipment policy. If these requirements are not met, the asset is recorded as a prepaid asset and is amortized over the life of the lease.
   

IV. Other Lease Topics
Note that these topics apply to both Lessee and Lessor arrangements.

A. Record Inter-Tub Leases Properly
When assets are leased between tubs, they may only be accounted for as operating leases, and no gain or sale may be recognized on the transaction. Consult the University’s Internal Billing Transactions Policy and Internal Transfer Policy for the appropriate accounting treatment.

B. Account for executory costs correctly
Executory costs include utilities, repairs, maintenance, insurance, common area expenses, and taxes paid for the leased asset during its contract agreement period. If significant executory costs are determinable at the lease commencement date, tubs should include these amounts in the lease payment present value measurement as part of the lease classification assessment in section.

C. Maintain supporting documentation
For all leases, follow the records retention schedule legal contract and agreement documentation requirements. Generally, schools and units are required to keep the following documentation on file for the life of the leased asset plus an additional seven years. Some funding sources may require additional retention periods (e.g., sponsored funding).

• The master lease agreement
• A copy of the completed “Lease Classification Form” (Appendix C, completed with the facts of the lease).
• Supporting documentation for any additional assumptions used in determining whether the lease is finance or operating.
• For finance leases, tubs must also maintain a schedule of payments showing amortization of the lease-related liability.

D. Make required disclosures for year-end lease reporting
The University is required to disclose the total gross assets and liabilities for finance and operating leases as well as both finance and operating lease commitments for each of the next five years and thereafter in its annual financial report. FAR coordinates the process of obtaining this information from the tubs each fiscal year-end using a reporting materiality threshold of $100,000 per lease.

Definitions
Cash Basis: Recognizing lease expense as cash is paid.

Control: Control of an asset means that the lessee has the right to obtain substantially all of the economic benefits for the use of the asset and the right to direct the use of asset.

Commencement date: The date when the lessor makes the asset available for the lessee’s use. The lease classification analysis and its inputs are measured at this date.

Direct-Financing Lease: A lessor only type lease that meets none of the five criteria in Section I but meets both additional criterions in Lessor Accounting section III.

Effective interest rate: The interest rate on a loan or financial product restated from the nominal interest rate as an interest rate with annual compound interest payable in arrears. It is used to compare the annual interest between loans with different compounding terms (daily, monthly, annually, or other).

Executory cost: Costs of an ongoing lease agreement. Executory costs include utilities, repairs, maintenance, insurance, common area expenses, and taxes paid for the leased asset during its economic life. If the amounts become determinable after the lease commencement date, they are considered period costs and therefore must be expensed as incurred.

Fair market value: Probable price at which a willing buyer will pay to a willing seller when (1) both are unrelated, (2) know the relevant facts, (3) neither is under any compulsion to buy or sell, and (4) all rights and benefit inherent in (or attributable to) the item must have been included in the transfer.

Finance lease: A lease considered to have the economic characteristics of asset ownership where the lessee obtains substantially all of the control and benefits of the asset. A finance lease is treated as a purchased asset for accounting purposes, meaning it is recorded as an asset on the balance sheet and depreciated over time.

Fixed payments: Unavoidable payments that are specified in the lease. Fixed payments represent

amounts that will not vary based on changes in facts or circumstances that occur after the commencement date.

Incremental borrowing rate: Interest rate a lessee would have to pay if, instead of leasing, they finance the purchase of the same asset.

Initial direct costs: Initial direct costs are the incremental costs of entering into a lease that are only incurred as a direct result of the lease being executed. Examples of initial direct costs include commissions paid upon executing the lease and costs paid to existing tenants as an incentive to vacate the leased premises. These costs are incurred only if the lease is executed and would not have been incurred if the lease had been drafted and negotiated, but ultimately had not been signed by both parties. These costs exclude legal fees, costs of evaluating the prospective lessee’s financial conditions, costs of negotiating lease terms, and general overheads.

Inception date: The date when the contract is executed. A tub must determine whether a contract is or contains a lease at this date.

Intangible asset: An asset with no physical substances such as internet domain names, licensing agreements, broadcast rights, patent technology, trademarks, etc.

Lease: A contract is or contains a lease if the contract conveys the right to control the use of identified property, plant, or equipment (PP&E) for a period of time in exchange for consideration.
In order to control the use of an asset, the tub should determine at lease inception if it has both the ability to determine how the asset is used and the right to substantially all of the economic benefits arising from the asset. The determination of whether or not a contract is a lease or contains a lease is made at the lease inception date. For additional guidance determining if a contract is or contains a lease See appendix A.

Lease bonus: An amount paid by a lessee to a lessor as consideration for granting a lease, usually as a lump sum; this payment is in addition to any rental or royalty payments.

Lease incentives: Lessor provided incentives paid, or payable, to the lessee that reduce the lessee’s lease payment. A rent-free period, an up-front cash payment, payment for tenant improvement allowance, and payment of lessee costs, such as moving expenses, are common lease incentives.

Lessee: A person or entity who rents land or property. An individual or entity who has the right to use something of value gained through a lease agreement with the real owner of the property (lessor).

Lessor: The owner of an asset that is leased under an agreement to a lessee.

New leases: For purposes of this policy, new leases are leases entered into after 6/30/2022, including addenda to or extensions of existing leases.

Operating lease: From the perspective of a lessee, any lease other than a finance lease. Operating leases are treated as rental expenses by the lessee tub. Detailed operating lease information must be retained and submitted to FAR at year-end for proper financial statement recording and disclosure. From the perspective of a lessor, any lease other than a sales-type lease or a direct financing lease.

Period of Time: May be described in terms of the amount of use of an asset (e.g., number of production units ) or the number of years or months specified in an agreement.

Residual value guarantee: A guarantee made to a lessor that the value of an underlying asset returned to the lessor at the end of a lease will be at least a specified amount.

Right of Use (ROU) Asset: An asset that represents a lessee’s right to use an underlying asset for the lease term.

Sales-Type Lease: A lessor only type lease that meets one or more of the five criteria in Section I.

Straight Lined Reporting: The usage of the rental arrangement is on a consistent basis over time (e.g., used at about the same rate month to month) and therefore the expense is taken consistently over the lease term. To calculate straight-line lease expense, aggregate the total cost of all payments and divide by the total contract term.

Variable payments: A variable payment is a payment in a lease that varies based on changes in facts and circumstances occurring after the commencement date, other than the passage of time. They will be adjusted subsequently and reflected as an operating expense for operating and finance leases in the period in which they occur. The only variable payments included in “lease payments” are those that are based on an index or rate.

Contact/Responsible Office
Financial Accounting and Reporting: Associate Director of Financial Reporting or your Tub Analyst

Revision History
07/01/2022 – Formalized policy to document changes made 07/01/2019 to the Lease Accounting Standards. Harvard completed an historical review (7/1/19-6/30/22) and made adjustments as needed to comply with the new standards.

07/01/2014 – Formerly called Accounting for Leases