Account for a Capital Lease
Capital leases are an essential part of the financing for many businesses. Accounting for capital leases requires a thorough understanding of the lease agreement terms, the accounting standards, and the financial reporting requirements. In this guide, we will provide you with a comprehensive overview of the accounting for capital leases, including the types of capital leases, the accounting treatment, and the financial statement presentation.
Types of Capital Leases
Capital leases are lease agreements that transfer the ownership of the leased asset to the lessee at the end of the lease term. There are two types of capital leases: finance leases and operating leases.
Finance Leases
Finance leases are lease agreements that transfer the risks and rewards of ownership to the lessee. Under a finance lease, the lessee is responsible for maintaining and insuring the leased asset, and the lease payments are structured to cover the cost of the asset plus interest. The lessee records the leased asset as a non-current asset on the balance sheet, and records the lease liability as a non-current liability.
Operating Leases
Operating leases are lease agreements that do not transfer the risks and rewards of ownership to the lessee. Under an operating lease, the lessor is responsible for maintaining and insuring the leased asset, and the lease payments are structured to cover the cost of leasing the asset. The lessee records the lease payments as an expense on the income statement, and does not record the leased asset or lease liability on the balance sheet.
Accounting Treatment
The accounting treatment for capital leases depends on the type of lease agreement.
Finance Leases
Under a finance lease, the lessee records the leased asset as a non-current asset on the balance sheet, and records the lease liability as a non-current liability. The lessee amortizes the leased asset over its useful life, and records interest expense on the lease liability. The amortization and interest expense are recorded as separate line items on the income statement.
Operating Leases
Under an operating lease, the lessee records the lease payments as an expense on the income statement, and does not record the leased asset or lease liability on the balance sheet.
Lease accounting Under Accounting Standards 2016-02
Under Accounting Standards Update 2016-02, leases are classified as either finance leases or operating leases based on whether the lease transfers substantially all of the risks and rewards of ownership to the lessee. For finance leases, the lessee is required to recognize the leased asset and lease liability on the balance sheet, and amortize the leased asset over its useful life while recording interest expense on the lease liability.
For operating leases, the lessee is not required to recognize the leased asset and lease liability on the balance sheet, and instead records lease payments as an expense on the income statement. The update also requires enhanced disclosures in the footnotes of the financial statements related to leases, including lease terms, payments, and significant judgments and assumptions made in applying the lease accounting standard.
Financial Statement Presentation
The financial statement presentation for capital leases depends on the type of lease agreement.
Finance Leases
Under a finance lease, the leased asset and lease liability are presented on the balance sheet. The leased asset is presented as a non-current asset, and the lease liability is presented as a non-current liability. The amortization and interest expense are presented as separate line items on the income statement.
Operating Leases
Under an operating lease, the lease payments are presented as an expense on the income statement.
Conclusion
Accounting for capital leases requires a thorough understanding of the lease agreement terms, the accounting standards, and the financial reporting requirements. In this guide, we have provided a comprehensive overview of the accounting for capital leases, including the types of capital leases, the accounting treatment, and the financial statement presentation. By following the guidelines outlined in this guide, businesses can ensure that they are accounting for their capital leases correctly and in compliance with accounting standards.
