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What Is A Capital Lease?

What is a capital lease?

Capital leases have become top of mind amongst accounting departments with the new lease accounting standards becoming effective for public and private companies. Strictly speaking, when the renter uses an asset and records the lease on the balance sheet, it is considered a capital lease. A capital lease is similar to a purchase of an asset, while an operating lease is treated differently under GAAP. Capital leases are very common in industries working with large assets, such as airlines.

In 2016 the Financial Accounting Standards Board (FASB) amended accounting rules, requiring 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. While capital leases are rental agreements, those leases will be viewed by GAAP as a purchase if certain criteria are met.

Capital lease criteria

To be classified as a capital lease, the following criteria must be met:

  • 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
  • The entity renting the asset does not really own the asset unless they exercise the buy option at the end of the lease, the lease must contain a purchase option at the end of the lease term

Because capital leases are financing agreements, organizations need to break down lease payment entries into expenses based on the interest rate and depreciation expense.

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 and integrates with existing accounting systems.

Matt Waters, CPA

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