A capital lease is a kind of lease in which the lessee records the assets to be leased in the same way as it owns the assets that are going to be leased. In this concept the lessor is going to be tagged as a third party that is financing the assets actually owned by the lessee. A lease is given the status of capital lease if it meets the following criteria:-
- Seventy five percent of the asset useful life period is covered in the lease
- if the lease expires the asset can be purchased on the rate that will be lower than the market rate
- On lease expiration the owner ship of the leased asset will be shifted to lessee
- The present value of the minimum lease payment must be equals to or above than 90 percent of the fair value of the asset.
There are a number of steps involved in the accounting of a capital lease that can be explained as under:-
- Initial Recordation of the lease
- Lease Payments
In the initial recordation step the present value of all the lease payments is recorded that is the recorded cost of the asset. This amount is recorded as a debited to the fixed asset amount and as a credit to the capital lease account. In the next step the lease payments are received from the lessor and recorded in such a way that a portion of these payments is used as interest expense and rest is used to reduce the capital lease account balance. In the depreciation step a leased asset is depreciated in the same way as any other asset. When a leased asset is disposed off the fixed asset account is debited and the depreciation account is credited.
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