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What Is A Capital Lease?

What is a capital lease?

The term “capital lease” comes from generally accepted accounting principles established in the late 1970’s regarding lease accounting. FAS 13, later re-codified as ASC 840 required lease testing based on four bright-line tests to determine capital or operating treatment. Capital leases were presented on the balance sheet with corresponding assets and liabilities, operating leases were expensed on a straight-line basis.

In 2016 the Financial Accounting Standards Board (FASB) amended accounting rules, requiring virtually all lease contracts with terms longer than one year to be added to financial statements effective December 15, 2018 for public companies and December 15, 2019 for private companies. Most existing capital leases will be transferred from ASC 840 guidance to ASC 842 guidance with little impact, however the name has changed from “capital lease” to “finance lease” to better align with international accounting (IFRS) standards.

Capital lease criteria

To be classified as a capital lease, one of the following criteria needed to be met (the bright-line tests):

  • The term of the lease is greater or equal to 75 percent of the useful economic life of the asset
  • The present value of the lease rental is more than 90 percent of the fair value at the time of lease
  • A transfer of ownership exists
  • A bargain purchase option exists

Data points typically needed for the accounting calculations for capital leases under ASC 840 and now virtually every lease under ASC 842 include: lease possession date, lease expiration, option dates and an assessment if the option is reasonably certain to be exercised, rent payment amounts, the company’s incremental borrowing rate, and others.

For many, new requirements mean new accounting software As part of compliance initiatives with all FASB and IASB lease standards (ASC 840/FAS 13, ASC 842 and IFRS 16), many companies are shopping for new lease accounting software solution to manage and report on real estate, equipment and other leased assets. See how CoStar’s solution analyses and classifies leases for new lease accounting requirements, generates journal entries, calculates percentage rent obligations, integrates with existing accounting systems and even runs parallel reporting under old and new accounting standards.

Matt Waters, CPA

Lease Accounting Subject Matter Expert with over 15 years of Management Experience in Accounting and Finance