How to Account for a Capital Lease

December 22, 2014 Published by
Post Categories: Tax AccountingAdvice For You

If you are a Canadian business owner or manager, you need to make sure that you have a good grasp of fundamental accounting principals. This knowledge is important because it will allow you to analyze your firm’s financial statements, and identify problem areas or areas for improvement. One key thing that needs to be understood is how to go about accounting for a capital lease. At Hogg, Shain, and Scheck, our professional accountants can help you do this.

What is a capital lease?

The basic impression many people have regarding a lease is that it is, in effect, a rental. In accounting practice, a rental is called an operating lease. This is the type of lease that generally applies when a company (or leasee) rents a property for use as an office, or rents a truck for daily/weekly delivery purposes. However, there is also what is known as a capital lease. This is very different from an operating lease in that a capital lease acts very similarly to the purchase of an asset. Because of this, capital leases are accounted for in the company’s books as if the company bought the asset over time.

Before going into the particular accounting entries used for a capital lease, it is important to lock in exactly when a lease can be considered a capital lease. There are four questions to ask:

  1. When the period for the lease of the item is over, does the ownership of the item automatically transfer to you?
  2. At the end of the lease period, are you given the option to buy the item for an amount that is well below what the market usually charges? This is also known as a bargain purchase option.
  3. Given the estimate of how long the useful life of the item is, does the lease period cover at least three-fourths of that length of time?
  4. After accounting for the present value of all the minimum lease payments, is this value at least 90% of the fair market value of the item or asset?

If the answer to any of these questions is yes, your lease is considered a capital lease and should be accounted for as such.

At Hogg, Shain, and Scheck our professional accountants specialize in helping you understand what a capital lease is and how to properly account for it. Call us today to answer any questions you may have or to set up an appointment to speak to one of our team members.

Related blog post: Negotiate a Better Lease? Know the Accounting and Tax Implications of Lease Inducements