See Also:
Fixed Assets
Current Liabilities
Long Term Debt
Sale and Leaseback
Working Capital
Secured Claim
Capital Lease Agreement
A capital lease is a type of long-term
lease agreement. A capital lease is recorded on the lessee’s balance sheet. This type of lease typically spans most of the useful life of the asset. In a capital lease agreement, the lessee, the party receiving the asset, assumes both the risks and benefits of ownership. A capital lease is also called a financial lease or finance lease.
Capital Lease Treatment According to
GAAP, property leased with a capital lease agreement must be recorded on the lessee’s balance sheet. The leased property is recorded as an asset with a corresponding liability. The asset is depreciated. The liability is amortized. Payments of the interest and principal are considered separate expenses on the
income statement.
According to GAAP, if a lease agreement meets one or more of the following four criteria, it must be treated as a capital lease.
1. The lease agreement includes a clause stipulating that ownership of the asset automatically transfers to the lessee at the end of the lease.
2. The lease agreement includes a clause stipulating that the lessee can purchase the asset at a discounted price at the end of the lease.
3. The duration of the lease spans at least 75% of the asset’s useful life.
4. The present value of the lease payments is equal to at least 90% of the original value of the asset.
Finance Lease versus Operating LeaseThere are two main differences between capital (finance) leases and
operating leases.
1. With a capital lease, the lessee must record both a lease asset and a lease liability on their balance sheet. With an operating lease, this is not required.
2. With a capital lease, the lessee assumes both the risks and benefits of owning the asset. With an operating lease, the lessor retains the risks and benefits of owning the asset throughout the duration of the lease.