There are differences in the treatment in the financial statements for capital and operating leases. An operating lease is a contract to rent equipment in which the company incurs in an expense. The asset is never owned by the company, thus the value of the lease is not included within the balance sheet. …
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A capital lease is considered an acquisition of ownership once the lease is paid out. The lessee must record the lease as an asset. The four criteria that must be considered by accountant to record a lease as a capital lease are: The lease transfers ownership of the property to the lessee The lease contains a bargain purchase option The leas is equal to 75% or more of the economic life of the leased property The present value of the lease payments equals or exceeds 90% of the fair market value of the leased property (Weygand & Kieso & Kimmel, 2003, pg. 658). Weygandt, J., Kieso, D., Kimmel, P. (2002). Accounting Principles (6th ed.). New York: John Wiley & Sons. 2. I think that capital leases are better investment options than operating leases. I compare the difference between an operating leases and a capital leases to the difference between been a renter and a homeowner. Companies that incur in operating leases contracts are throwing money away because they will pay thousands of dollars and will never own the equipment. Sometimes due to the nature of the project it is better to use operating leases. For example if a project has a completion elapsed time of 6 months, it is cheaper to obtain equipment using short operating lease contracts. 3. When you think about the criteria of having a leases for the duration of at least 75% of the useful life of equipment it makes sense that capital lease transfer ownership. The person that pays the lease will pay the owner of the equipment the majority of the value of the asset. I think the use of capital leases is a good way to add value to the balance sheets of a company. The equipment will increase the total assets account of the company. Since the balance sheet is based on the basic accounting equation it must balance itself out, thus there is need of a liability to be included in the balance sheet to offset the asset entry. 4. The four criteria you mentioned in your response are right on target. The first criterion of ownership establishes that a capital lease will lead to ownership of the equipment by the lessee once the contract is complete. A capital lease is similar to a contract to buy a home because the homeowner does not actually fully own the home until is completely paid. If the homeowner fails to pay his monthly payment for more than three consecutive months the bank could foreclose on the home and take back the house. The fair value criterion also completely justifies the ownership privileges in a capital lease. 5. Weekly Summary During week two of the course I learned a lot about accounting theory. The classroom discussion was very informative. I now clearly understand the difference between an operating lease and a capital lease. The week two individual paper cover some very specific accounting topics dealing with some unusual transactions. I use to believe that the inventory reflected in the balance sheet was based on historical cost only. I learned this week that companies make adjustment to lower the inventory when the current replacement cost is lower. Another interesting accounting topic I learned during my research for the week two paper was that accountants can capitalize interest on construction projects. 6. The total inventory of the company at the end of 2009 was 282,000 units. Using LIFO the valuation of the inventory is illustrated below 10000 15 150000 22000 18 396000 250000 20 5000000 282000 19.67 5546000 The average cost per unit of the company at the end of the year was $19.67 per unit. If the company decides to purchase the 40,000 units at $17 before the end of the year the valuation of the inventory is illustrated below 10000 15 150000 22000 18 396000 250000 20 5000000 40000 17 680000 322000 19.34 6226000 The decision of
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Under the finance lease, all the risks and rewards that come with ownership are transferable to the lessee. To the lessee, it forms both an asset and liability while to the lessor it is a receivable. On the other hand, operating leases form an expense to the
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