Types of Leases

A. Operating Lease

An operating lease is basically a rental agreement. The lessee records rent expense for each of the lease payments.

B. Capital Lease

A capital lease is a rental agreement in form, but the substance of the transaction is an asset purchase. With capital leases, the lessee records and asset and related liability rather than rental expense. The lessee also record depreciation on the asset. If a lease agreement meets any one of the following criteria, it is considered to be a capital lease:

1. The lease term is equal to 75% or more of the life of the asset.
2. The present value of the minimum lease payments is equal to at least 90% of the cost of the asset.
3. The lease transfers ownership of the asset to the lessee at the end.
4. The lease contains a bargain purchase option (the option price is so low we know that the lessee will exercise the option to purchase the asset.