The Role of Operating Lease Accounting in Project Management

by Daniel Raymond · September 24, 2024

Efficient project management is critical to ensuring that organizations meet their objectives while optimizing resources. Whether managing large-scale construction projects, IT implementations, or strategic initiatives, keeping track of finances, resources, and timelines is essential. One area that project managers must increasingly consider is how leases, especially operating lease accounting, can impact the financial health and performance of a project.

Table of Contents

Operating lease accounting, which governs how companies account for leases under new regulations like the ASC 842 standard, plays a significant role in the financial planning and execution of projects. The ability to accurately track and report leased assets—whether equipment, office space, or technology—can influence project decisions, timelines, and budget allocation. This article will explore the intersection of operating lease accounting and project management, highlighting how project managers can leverage this financial tool to enhance project outcomes.

Understanding Operating Lease Accounting

Before diving into how operating lease accounting impacts project management, it’s essential to grasp the concept itself. In accounting terms, an operating lease is a contract that allows the lessee (the company) to use an asset without transferring ownership. Unlike capital leases (now known as finance leases), operating leases don’t place the asset on the balance sheet until recent accounting standard changes, particularly ASC 842, which now requires the recognition of lease liabilities and right-of-use (ROU) assets on financial statements.

Operating leases are typically used for assets that a company only needs temporarily or doesn’t plan to own outright, such as office space, equipment, or vehicles. These leases provide flexibility, allowing companies to operate without the upfront costs associated with purchasing assets. However, under ASC 842, even operating leases must now be accounted for on the balance sheet, impacting financial statements and project management calculations.

The Impact of Lease Accounting on Project Management

Operating lease accounting intersects with project management in several important ways, particularly when it comes to budgeting, resource allocation, and financial reporting. Project managers are tasked with juggling various components to ensure the successful completion of a project, and the financial treatment of leases can significantly impact project costs and timelines. Let’s take a closer look at some key considerations:

1. Budgeting for Leased Equipment and Assets

Leased assets, such as machinery, software, or vehicles, are often critical to the success of a project. However, understanding how the costs associated with these leases will be treated under the organization’s financial structure is crucial for accurate budgeting. Under operating lease accounting, the expenses associated with leases are now recognized over the lease term, meaning that project managers need to account for these costs in both the short and long term.

The ability to spread lease costs over the life of a project can offer financial flexibility. However, with the new ASC 842 standard requiring both assets and liabilities to be reported on the balance sheet, this can also affect the company’s debt-to-equity ratio and other financial metrics, influencing decision-making in project planning.

2. Cash Flow Management

Effective cash flow management is a cornerstone of project management, and leasing is often used as a strategy to preserve cash. Leasing enables companies to pay for only the usage of an asset, not its full purchase price, which can free up cash for other aspects of a project, such as hiring, research, or marketing.

Under operating lease accounting, project managers need to track lease payments and account for the timing of these payments within the broader project timeline. Proper cash flow management involves scheduling these payments to align with project milestones and ensuring that the lease terms support the overall financial health of the project.

3. Risk Management

Leasing assets can offer flexibility, but it also introduces risk, especially when the terms of the lease don’t align with the project’s needs. For instance, a project that runs over schedule might require the extension of lease terms, resulting in additional costs. On the other hand, terminating a lease early can lead to penalties or loss of the asset before the project is complete.

Project managers must carefully assess lease agreements to mitigate these risks. Understanding the implications of operating lease accounting—particularly how lease liabilities are recognized and managed—can help project managers anticipate potential pitfalls and ensure they have contingency plans in place.

Key Considerations for Project Managers

Incorporating operating lease accounting into project management involves more than just financial reporting. It requires a holistic understanding of how leases affect the entire lifecycle of a project, from initiation to completion. Here are some best practices that project managers can adopt to better integrate lease accounting into their processes:

Early Involvement of Financial Teams
To ensure accurate budgeting and financial forecasting, project managers should involve the company’s finance team early in the project planning process. Finance teams can provide insights into how leases will be accounted for under operating lease accounting rules, helping project managers avoid unexpected costs or financial setbacks later in the project.
Align Lease Terms with Project Timelines
A mismatch between lease terms and project timelines can lead to cost overruns or delays. Project managers should negotiate leases that align closely with the project’s schedule, including provisions for extensions or early termination if necessary. Flexibility in lease agreements can provide critical support for projects that encounter unexpected challenges.
Use Technology to Track Leases
Today’s project management tools often include features that allow managers to track lease agreements, payment schedules, and asset usage. Leveraging software solutions that integrate financial data, project timelines, and lease information can help project managers stay on top of costs and ensure that leased assets are used effectively throughout the project.
Consider the Long-Term Impact on Financial Statements
While leasing offers short-term financial flexibility, project managers need to be mindful of how operating lease accounting affects the company’s financial position over time. Under ASC 842, operating leases now appear on the balance sheet, which can impact the organization’s financial ratios and borrowing capacity. Understanding these implications allows project managers to make more informed decisions about leasing versus purchasing assets for long-term projects.

By keeping these considerations in mind, project managers can effectively navigate the complexities of lease accounting while ensuring that their projects stay on track and within budget.

The Future of Lease Accounting and Project Management

As businesses continue to adopt more flexible and scalable models, including leasing rather than purchasing assets, the intersection of operating lease accounting and project management will only become more pronounced. The transition to ASC 842 has already shifted how organizations think about leasing, and as companies continue to rely on leasing for operational efficiency, project managers will need to adapt to the new financial landscape.

Looking ahead, technological advancements in lease management software and project management tools will likely make it easier for project managers to account for leased assets and integrate lease-related costs into broader project plans. These tools will streamline communication between project teams and finance departments, making the financial implications of leases more transparent and easier to manage.

Conclusion: Balancing Lease Accounting with Project Success

Incorporating operating lease accounting into project management isn’t just a matter of adhering to new accounting standards; it’s about optimizing resources, managing risks, and ensuring long-term financial sustainability. Leased assets can offer significant advantages for projects—allowing organizations to operate with greater flexibility and preserve capital—but understanding how these leases affect financial performance is crucial for effective project management.

By integrating lease accounting into the project planning process, project managers can make more informed decisions about resource allocation, budgeting, and risk mitigation. This not only ensures compliance with accounting standards but also enhances the overall success of the project, delivering better outcomes for both the organization and its stakeholders.