What is an Example of a Capital Lease?

A capital lease is a financial arrangement in which a lessor or leasing company grants the lessee or occupant of a business property the right to use and maintain an asset over a period of time. In most cases, the assets and liabilities associated with a capital lease are recorded in the balance sheet. This is a major difference from the operating lease, which only affects the business’s income statement. The differences in the treatment of these two types of leases can have a significant impact on the business’s taxes.

Capital leases are similar to other financial agreements such as loans and borrowings, although they are usually recorded as fixed assets. For this reason, they may be eligible for depreciation. However, they must meet certain criteria to qualify. Typical examples of these leases include equipment, such as machinery, buildings, ships and aircraft. Companies often use capital leases to purchase specialized or heavy equipment and for land.

A capital lease is akin to a loan in that the lessee will make payments over the course of the lease. The lessee will also have the option to buy the asset at the end of the lease. If the terms of the lease are favorable, the lessee might also have the option to claim the value of depreciation, which is a benefit not enjoyed by the lessor.

A capital lease is different from an operating lease in that the ownership of the leased asset is transferred to the lessee at the end of the lease. However, the lessor retains the title to the property during the lease period. Hence, it is important to understand the characteristics of a capital lease.

For a capital lease to be considered an accomplishment in accounting, it must satisfy certain criteria. First, it must have a useful life greater than seventy-five percent of the total useful life of the asset. Additionally, it must have a present value of lease payments greater than ninety percent of the asset’s fair market value at the beginning of the lease. It must also have a bargain price at the end of the lease.

The bargain value of a capital lease is the sum of the cost of the asset plus the depreciation of the asset over its useful life. If the asset has a useful life of ten years, a debit of $10,000 will be recorded each year in the depreciation expense account.

When a capital lease is purchased, the lessee will have the option of purchasing the asset at the end of the lease. However, since the lessor will have the option to retain the property, the bargain value is usually lesser than the cost. Another advantage of a capital lease is that it transfers the responsibility for maintenance to the lessee.

In a capital lease, the lessee will have to follow the proper methods of depreciation and capitalize the asset. Depreciation is calculated by calculating the salvage value and periodic depreciation. Both are based on the asset’s actual cost and the salvage value of the asset. The accumulated depreciation accounts are also included in the lessee’s balance sheet.