Contemporary Accounting Leases

A lease is a contractual agreement between two parties the lessor and the lessee. The lessor owns the property and agrees to let the lessee use the property for a period of time for periodic payments. Between the two parties there can be two different types of lease agreements. The first is called an operating lease. With an operating lease, the lessee merely uses the asset of the lessor for a period of time while paying a periodic fee (ex. Monthly rent). In an operating lease there is no transfer of ownership. The second type of lease is called a capital lease which transfers substantially all of the benefits and risk inherent in ownership of property to the lessee. Capital leases can be looked at as an accounting transaction which is basically an installment purchase in the form of a lease agreement.
For the lessee, in order for a lease to be classified as a capital lease one of the four following criteria must be met: 1) Ownership is transferred at the end of the lease, 2) The lease contains a written option for a bargain purchase, 3) The lease term is equal to 75 percent or more of the estimated economic life of the leased asset, or 4) The present value of the minimum lease payments exceeds or equals 90 percent of the fair value of the leased property. Once classified as a capital lease the lessee should account for this transaction as an acquisition of both the asset (equal to the PV of the payments of the capital lease) and the liability associated with that asset. With regards to the lessor, in order for a lease to be considered a capital lease it must meet all three of the requirements listed: 1) The lessee must “own” the property (this means that any of the lessee requirements must be met), 2) The collectability of the lease payments is reasonably predictable, and 3) Uncertainties do not exist regarding any non-reimbursable costs to be incurred by the lessor. In addition, at inception of the lease, the lessor must then determine if the capital lease

Cited: Financial Accounting Standards Board (FASB), Conceptual Framework: Statement of Financial Accounting Concepts No. 8, Financial Accounting Foundation, September 2010. http://www.srr.com/article/proposed-accounting-game-changer-respect-leases, A Proposed Accounting “Game Changer” With Respect to Leases, Jason J. Krentler, Stout Risius Ross, Inc., 2012. Terney ,Wolk, and Dobb. "The Economies of Financial Reporting Regulation." Accounting Theory: A Conceptual and Institutional Approach. 5/e ed. N.p.: Southwestern, n.d. 100-04. Print. Leftwich, Richard. "Accounting Information in Private Markets: Evidence from Private Lending Agreements." The Accounting Review LVIII.1 (1983): n. pag. Print.