Question

define a capital lease. What is the criteria to categorize a lease as a capital lease? Which financial statements are impacted upon the determination that a lease is a capital lease?

Answer 1

A capital lease is a type of lease agreement in which the lessor simply finances the leased asset. He agrees to transfer ownership right to lessee after completion of lease period. In short, all other rights of ownership rest with lessee in the capital lease. Therefore it is recorded as the fixed asset in lessee’s books of account. Only interest portion is recorded as a part of lease payment.

To be called as a capital lease, the lease should satisfy at least one of four given criteria:

• At the end of lease term, the leased asset’s title should pass to lessee automatically.
• Lease should contain a bargain purchase option so that lessee may have option to acquire the leased asset at the value less than its fair market value at the completion of lease term
• Lease term should be greater than 75% of estimated economic life of an asset.
• The present value of lease payment should be higher than 90% of the fair market value of asset during the conception of lease term.

Capital lease affects balance sheet and income statement. In balance sheet, leased asset will be recorded as asset and also company will recognize lease liability which will be equal to present value of minimum lease payments. In income statement, the depreciation would be recorded.