Concept explainers
State the four criteria used to identify the lease as a capital lease or operating lease by the lessee.
Explanation of Solution
Lease: Lease is a contractual agreement whereby the right to use an asset for a particular period of time is provided by the owner of the asset to the user of the asset. The owner, who possesses the asset, is termed as ‘Lessor’ and user, to whom the right is transferred to, is termed as ‘Lessee’.
Operating leases: In an operating lease lessor retains all ownership risks and responsibilities.
Capital leases: In capital lease all the ownership risks and responsibilities are transferred from the lessor to the lessee.
The criteria for defining the lease as capital lease or operating lease:
As per the notes issued by Financial Accounting Standard Board (FASB), the following are four criteria to determine is a lease is a capital lease or an operating lease:
- 1. Transfer of ownership: The asset is transferred to lessee at the end of the lease period concerned.
- 2. Purchase (bargain) option: The purchase option is exercisable when the purchase price is sufficiently lower than expected fair value.
- 3. Economic life: The economic life of the lease period is 75% or more than the useful life of the asset.
- 4. Value recovery: Present value of lease payments is greater or equal to 90% of the fair value.
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Chapter 20 Solutions
Intermediate Accounting: Reporting and Analysis
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- A lessor will record interest income if a lease is classifi ed as:A . a capital lease.B . an operating lease.C . either a capital or an operating lease.arrow_forwarddistinguish between a fi nance lease and an operating lease from the perspectives of the lessorand the lessee;arrow_forwardWhich of the following is a required financial statement presentation by a lessee for both capital leases and operating lease? A. Amortization Expense and Interest Expense B. Lease Expense C. Right-of-Use Asset and Lease Liability D. The reduction of the Lease Liability as a financing activityarrow_forward
- A lessee should classify a lease transaction as a finance lease if it is noncancelable and one or more of the five classification criteria are met. Otherwise, it is an operating lease. What are these criteria? Provide 2-3 reasons why a company would choose to lease an asset versus purchasing?arrow_forwardLease liability and right of use asset are accounts used by the lessee in a finance lease. Are the components used in computing the right of use asset all similar to the components that make up the lease liability?arrow_forward
- Intermediate Accounting: Reporting And AnalysisAccountingISBN:9781337788281Author:James M. Wahlen, Jefferson P. Jones, Donald PagachPublisher:Cengage Learning