Week Three Team Assignment - Essay Example

I think that the four criterion rule is absolutely necessary because not all leases should qualify as capital leases. A capital lease is treated much differently than an operating lease in the accounting books of the company. A capital lease creates both an asset and a liability in the balance sheet of the company. When SFAS No. 13 qualifies a lease as a capital lease full disclosure of what is actually happing in the company is disclosed in the balance sheet of the firm. The first criterion is that transfer of ownership must occur in the contract lease.

This is absolutely necessary because without transfer of ownership a company cannot truly claim that the property is theirs. Failing to comply with this criteria completely justifies classifying a lease as operating instead of capital. In essence this criterion is making sure that companies to dot enter into a bunch of leases to inflate the value of their assets. An operating lease is basically entering into an arrangement to borrow a property for a specific period of time. The second criterion in SFAS No.

13 is that a lease must contain a bargain purchase option to qualify as a capital lease. The rationale for this stipulation is “if during the term of the lease the lessee can purchase the asset at a price substantially below its fair market value, the lessee will exercise that option, thus the lease should be reported as a leased asset on the lessee’s books” (Weygandt, et. al, 2002, pg. 657). It makes a lot of sense that a purchase option must exist in a capital lease because this clause creates the final buying transaction needed to acquire an asset.

The third criterion states that the lease term equals 75% or more of the economic life of the leased asset. I also agree a lot with this stipulation. In a capital lease the business must have the asset for the majority of the useful life. If a company holds a property for only a third of the time of its useful life the business has not really