What are lease obligations?

Lease obligations are commitments to make future payments under lease agreements. Under current accounting standards, most leases appear on the balance sheet as both an asset (the right to use the property) and a liability (the obligation to make payments). This applies to office space, equipment, vehicles, and other leased assets with a term exceeding 12 months.

Operating vs finance lease treatment

Under operating leases, payments are recognized as rent expense, spread evenly over the term. Finance leases treat the arrangement more like a purchase, with interest expense front-loaded and depreciation on the asset. Classification depends on factors such as the lease term relative to the asset's life, the present value of payments, and the transfer of ownership. Your CPA determines the appropriate treatment.

Lease obligations and loan covenants

Lenders examine lease obligations when evaluating creditworthiness. Large lease commitments reduce borrowing capacity. Some loan covenants explicitly limit total lease obligations or require including lease payments in debt service calculations. Review existing covenants before signing significant new leases.