When calculating assets, one must consider that many companies lease their long-term assets. This may include buildings, land and equipment. In accounting, a lease is categorized in two ways: as a capital lease or as an operating lease. Their categorization depends on the terms of the lease agreement.
Definition of a Capital Lease
A capital lease defines a lease whose terms of agreement transfers all the benefits and risks of ownership to the lessee. This could be indicated in a variety of ways. For example, by a lease term for 75 percent or more of the economically valuable life span of the asset. Or, it may be quite clear from the agreement that legal ownership will transfer to the leasee or that the leasee may purchase the item for a discounted price. Additionally, the present value of the minimum lease payment is equal to 90 percent or more of the fair market value of the asset.
To record a capital lease, one treats it similarly to a depreciable asset. However, there are two slight differences in procedure.
- With a depreciable asset, the asset is written off during the lifetime of the asset. For a capital lease, the ability to write off the asset is limited to the term of the lease. If actual ownership of the item is transferred, then obviously it would no longer be a leased item and thus treated as one would a depreciable asset.
- The current and accumulated expenses are amortized rather than depreciated.
GAAP requires that the details of the capital lease are revealed and disclosed in order to demonstarte further legitimacy to the lease.