Question

How does a lessee’s recognition of an operating lease differ from the recognition of a capital lease?

Answer 1

All lease from lessee,s point of view are classified as either operating or capital lease

in operating lease -

1. Rent expense equal to lease payment is recognized on the income statement.
2. Balance sheet is not affected.
3. The lease payment is reported on the cash flow statement in cash flow from operating activities.

in capital lease -

1. Asset is depreciated and both depreciation expense and interest expense is recognized on the income statement. Interest expense = lease liability X lease interest rate
2. The lower of present value of lease payment or fair value of leased asset is recognized as both an asset and liability on the balance sheet.
3. On the cash flow statement, the lease payment is separated into interest and principal components. The interest goes in the cash flow from operating activities and the principal in financing activities.

In a Capital Lease Test-

• Ownership: The lease transfers ownership of the property to the lessee by the end of the lease term.
• Estimated Economic Life: The lease term is equal to or greater than 75 percent of the estimated economic life of the leased property.
• Bargain Price Option: The lease contains an option to purchase the leased property at a bargain price.
• Fair Value: The present value of rental and other minimum lease payments, excluding that portion of the payments representing executory costs, equals or exceeds 90% of the fair market value of the leased property.

In a Operating lease test -

When the above capital lease conditions are not fulfilled its a operating lease .