What are Capital Leases on a Balance Sheet? The Capital Leases category appears as a long term liability on a Balance Sheet. A Capital Lease is a contract that allows the lessee to use the asset for a specific period of time. The corresponding asset is listed as a Capital Asset on the Balance Sheet.
A Capital Lease is recorded as a long term liability if the lease is considered a purchased asset for accounting purposes. Operating leases are considered rentals for accounting purposes and are recorded as an operating expense on the Income Statement.
If any one of the following criteria is satisfied, then a lease can be considered capital:
- Ownership is transferred during or after lease term
- Lease contains a bargain purchase price option at lower than fair market value
- Lease covers a major portion of the asset’s economic life (generally over 75%)
- Discounted value of net minimum lease payments covers substantially all (90% or more) asset’s fair value
The initial cost of the leased equipment is recorded as the present value of all lease payments during the term. The corresponding amount is setup as the liability which is often described as “Obligations under Capital Lease” on the Balance Sheet. The lease payments are then allocated against this amount similar to a loan payment where principal and interest are segregated.
For accounting purposes, we must record capital leased equipment as an asset and record amortization on the equipment. You also receive a deduction for interest paid portion of the lease payments. For tax purposes, you receive a full deduction for the lease payments (including principal portion) made during the fiscal year but the asset is not amortized.
If you have any questions about Capital Leases or other Balance Sheet items, get in touch.