By LeaseCrunch® on September 13, 2022 at 12:18 PM
First things first: Let’s set some definitions straight, because straight line expense is different from straight line amortization and straight line depreciation.
“Amortization” is a term used to refer to the decrease in value that an intangible asset, such as a lease, experiences over a set period of time.
And whereas amortization is a term used to describe the decrease in value of intangible assets, depreciation is used to refer to the decrease in value of tangible assets, such as a car, an office, or a piece of construction equipment.
In summary: leases are amortized, and underlying assets are depreciated, as depreciation is the decline in an asset’s value over the course of a lease.
The idea of amortization and depreciation is not a new concept that came about because of the new lease standards; the depreciation and amortization of assets and leases, respectively, has always been something that lessees and lessors have to do.
So now that we’ve cleared that up, what is straight-line expense?
What is the Straight-Line Method of Expense?
Straight-line method of expense is a method of documenting a lessee’s lease payments. With the straight-line method, all lease payments are distributed evenly across the term of the lease, regardless of when the lessee actually makes their lease payments.
Lease payments could be on a typical schedule, like month-to-month, or a lessee could pay everything up-front, or there could be a buy-out option at the end of the lease. The straight-line method cuts through all the noise of the varying times at which a lessee pays their rent and shows the payments distributed evenly over the course of the lease.
For example, in the case of a buy-out, you take the collective amount paid over the course of the lease—let’s say its $24,000—and the buy-out, which is $12,000, add them up ($36,000), and divide them by the duration of the lease in months (24 months). Thus, the straight-line expense is $3,000 every month.
How Do You Calculate Expense Using the Straight-Line Method?
Calculating straight-line expense is incredibly straightforward! You just take the total amount of lease payments and divide it by the number of months of the lease term.
What is a Straight-Line Expense Example?
Here’s an example of the straight-line method of expense:
Suppose a lessee doesn’t have to pay for 6 months of their lease according to the contract agreed upon by lessor and lessee. Therefore, the lease term commenced in January of 2020, even though the lessee doesn’t have to pay anything until July.
The monthly lease payments are $1,000 over the course of a 2 year lease, with only 18 of those months costing $1,000. Take $18,000 and divide it by 24 months and you have a straight-line expense of $750/month.
Why is Straight-Line Expense Important?
Straight-line expense serves multiple purposes in lease accounting:
- it is the expense of the lease, and regardless of when a lessee pays those expenses, it should be recognized over the course of a lessee using an asset.
- Just because the payments might not be month-to-month, there might be a cost within the months a lessee uses an asset, which is easier to account for if payments are recorded on a straight-line basis.
- It is required that organizations recognize expenses as they are incurred, so straight-line expense matches expenses over the proper time period during which an asset is used.
- This method of documentation is an attempt to eliminate hyjinxing.
- Straight-line expense helps match the usage of an asset over the term of the lease.
- Overall, straight-line expense is a more transparent way to do lease accounting, which is the overall goal and point of FASB, IFRS, and GASB)
How Many Years is Straight-Line Expense?
The length of straight-line expense is wholly dependent on a lease contract.
Lease Accounting Software for Straight-Line Method of Expense
The straight-line method of expense isn’t too difficult a concept to grasp and execute, but it can be as simple as the click of a button with LeaseCrunch’s lease accounting software.
Sign up for a demo today to see how much faster you could be performing your lease accounting!