Leasing is a vital financial mechanism enabling businesses to acquire assets without substantial initial capital expenditure. Traditionally, leases were classified as off-balance-sheet transactions, allowing lessees to report lease obligations solely in the footnotes of financial statements. This approach minimized the appearance of liabilities on financial reports, creating an illusion of lower debt levels and stronger financial health.

In 1976, the Financial Accounting Standards Board (FASB) established new guidelines requiring certain leases to be recognized on the balance sheet. These were termed capital leases, necessitating that the present value of lease payments be recorded as both an asset and a liability. Meanwhile, operating leases remained off-balance-sheet items.

For a lease to qualify as a capital lease under the previous standards, it had to meet at least one of the following conditions: (1) transfer of ownership at the lease’s end, (2) the existence of a bargain purchase option, (3) lease duration covering a significant portion of the asset’s useful life, (4) lease payments approximating or exceeding the asset’s fair value, or (5) the asset being highly specialized for the lessee’s use.

In 2019, the FASB introduced updated lease accounting standards under Accounting Standards Codification (ASC) 842, requiring lessees to recognize both operating and finance leases on the balance sheet. This reform aimed to curb off-balance-sheet financing and enhance financial transparency.

Under the new guidelines, lessees must record a right-of-use (ROU) asset and a corresponding lease liability for all lease obligations exceeding 12 months. The distinction between finance and operating leases remains relevant for income statement presentation. Finance leases recognize interest and amortization expenses separately, whereas operating leases report a single lease expense.

These regulatory changes have significantly improved the accuracy of financial reporting, offering investors and stakeholders a clearer understanding of a company's financial position. By reducing the potential for accounting manipulation, the revised standards enhance comparability and foster more informed decision-making in financial markets.