I am trying to get my head around this lease thing: 1. If lessor capitalizes lease, does it become operating lease for lessee? Someone has to show the asset on balance sheet! And vice-versa? 2. If lessor shows it as operating lease, why is there a depreciation charge involved? Thanks
In the case of a lessee, if one of the four conditions is satisfied, as per Peter Olinto of Stalla the acronym being SNOB: 1. S, from Seventy five percent (75%) of the asset’s economic life is leased 2. N, from Ninety percent (90%) of the PV of minimum lease payments 3. O, from Ownership transfer at the end of the lease 4. B, from Bargain purchase option The lease is a capital lease. Otherwise it is classified as operational. For the lessor, if none of the above conditions applies, than the lease is operational. If at a minimum one of the above conditions is complied with, and BOTH of the conditions regarding sales-type and direct-financing lease criteria are met, these being: 5. Collectibility of the minimum lease payments is reasonably predictable 6. No important uncertainties surround the amount of unreimbursable costs yet to be incurred by the lessor Than the lease is a capital lease. If one of the first four but not BOTH conditions regarding sales-type and direct-financing lease criteria are met, than the lease is again, operational. Furthermore, the lessor can classify the leases as: Sales-type Leases, meeting one or more of the 4 capital lease criteria and both sales-type and direct financing lease criteria, and give manufacturer’s or dealer’s profit (or loss) to the lessor (the fair value of the asset is not equal with the book value of the asset for the lessor) OR Direct Financing Lease, meeting one or more of the capital lease criteria, and both sales-type and direct financing lease criteria but do not give manufacturer’s or dealer’s profit (or loss) to the lessor (the fair value of the asset is equal with the book value of the asset for the lessor). As you can see, a lease can be classified as capital lease by the lessee and operational by the lessor (if the conditions regarding sales-type and direct-financing lease criteria are not met). It cannot be classified as capital lease by the lessor and operating lease by the lessee (as at least one of the first four conditions applies). If the lessor recognized the lease as capital lease, the lessor recognizes the sale, removes the asset from its books replacing it with receivables, and the amounts received under the lease are treated as principal and interest. If the lessor recognizes the lease as an operating lease, it records rental income received from the lessee. To answer the second question, if the lessor recognize the lease as operating, than it depreciates the leased asset as per its depreciation policy, showing depreciation under an “Equipment leased to others” account. Whatever expenses it incurs to maintain the equipment are registered as expenses. Other costs such as finder’s fee and/or credit checks are amortized over the life of the lease.