Division of Agricultural Sciences and Natural Resources • Oklahoma State University
AGEC-935
Capital Leases
A lease may be categorized as a rental of property or an
acquisition of property by financing. If the lease agreement
transfers essentially all ownership rights and risks to the les-
see, there is an acquisition of property. If ownership rights
and risks do not transfer to the lessee, the lessee is simply
renting the property. The distinction must be made when
accounting for the asset.
A capital lease is an arrangement that is termed a lease but
has the qualities of a purchase. This is sometimes referred to
as a lease-purchase agreement. The lessor may be a dealer
who also sells assets of the same type or a lending institution
which finances the lease. The lessee takes possession of
the property and is usually responsible for repair expenses.
The lessee is also required to make periodic lease payments
which are similar in amount to loan payments that would be
required to purchase the asset during the term of the lease.
The lessee acquires an ownership interest in the property
and also incurs a liability for the principal amount which was
financed, plus any interest accrued to the date of the balance
sheet. Generally Accepted Accounting Procedures (GAAP)
should be used to identify and report capital leases.1
Definitions
Capital Lease: A lease in which the lessee effectively acquires
ownership interest in the asset being leased.
Asset’s Economic Life: The economic life, or useful life,
of an asset is an estimate of the length of time, usually
number of years, that an asset will be used to produce
revenues. This estimate may be revised when it becomes
apparent that the original estimate is not correct.
Bargain Purchase Option: A bargain purchase option means
that the leased asset can be purchased by the lessee at
the end of the lease term for an amount significantly less
than the fair market value of the asset at that time.
Capitalizing the Lease: An accountin