1. Capital versus operating
Leases
Capital versus operating

2. Leases Agreement giving the right to use PPE for a set time period
Lessor – the owner of the property who gives up the right to use it to the lessee
Lessee – acquires the right to use the property from the lessor
Like a purchase /sale of PPE with 100% financing,
Tax implications
Convenience
May allow reduction in risk
Off balance sheet financing
Cancellation impact

3. How are leases classified?
Operating Lease
Capital Lease
Simpler
Off balance sheet financing (no asset and liability)
Short-term lease more common
Rent expense and rent revenue recognized
More complicated
Asset and liability listed –valued at present value of minimum lease payments not to exceed fair value
Substance over form (faithful representation)
Transfers ownership of property
Long-term lease more common

4. Capital leases “pretend purchase”
Lessee – if at least one capitalization criteria of the following is true:
1. Transfers ownership of property to lessee by end of lease term
2. The lease contains a bargain purchase option
3. The lease term is equal to at least 75% of estimated economic life of property
4. The present value of minimum lease payments is equal to 90% or more of fair value of leased property to lessor
Lessor – if the above is true and the following 2 additional items are true
1. The collectability of the minimum lease payments is reasonably assured
2. No important uncertainties surround the amount of unreimbursable costs yet to be incurred by lessor
“pretend purchase”
Transfers substantially all the risks and benefits of ownership

5. Capital lease
Record “leased” asset –value is present value of minimum lease payments
Interest rate is the lessor’s implicit interest rate if known and it is lower than lessee’s rate -- use lessee’s rate if lessor not known or higher than lessee rate
Record liability on lease
Depreciate leased asset
Accrue and pay interest as part of lease payment
Recorded very similar to a purchase with a high level of financing
for the lessee

6. Capital lease Sales-type lease: Direct financing lease: For the lessor
Sale of asset
creation of a receivable
Cost of goods sold and sales revenue
Inventory comes off the books
Unearned interest revenue becomes Interest revenue
Direct financing lease:
Creation of a receivable
A PPE asset comes off the books
Unearned interest revenue becomes Interest revenue
For the lessor