Question

Question: (Comparison of Different Types of Accounting by Lessee and Lessor)

Part 1: Capital leases and operating leases are the two classifications of leases described in FASB pronouncements from the standpoint of the lessee.

Instructions

1. Describe how a capital lease would be accounted for by the lessee both at the inception of the lease and during the first year of the lease, assuming the lease transfers ownership of the property to the lessee by the end of the lease.

Do not discuss the criteria for distinguishing between capital leases and operating leases.

Short answer

Answer

A lessee would account for a capital lease as an asset and a liability at the inception of the lease.

Step-by-step solution

Meaning of Capital leases

The transfer of ownership rights from one party to another at the completion of the lease periodis term as a capital lease. A lessee might benefit from capital leasing by purchasing an asset at a lower cost than the market value.

Explaining how a capital lease would be accounted for by the lessee both at the inception of the lease and during the first year of the lease

At the start of the lease, a lessee would account for a capital lease as an asset and a liability. Rental payments would be split between a decrease in the liability and interest expenditure over the year. The asset would be depreciated in accordance with the lessee's standard depreciation strategy for owned assets, with the exception that, in some cases, the amortization period would equal the lease term.