Let’s get one thing straight: the term capital lease is on its way out. 

Old habits die hard, so the term is still being used, but with the advent of ASC 842 lease accounting standard, the term “finance lease” is being used to refer to what used to be capital leases. 

Still have questions? Don’t worry. We’ll answer any outstanding questions you might have below. 

Capital Lease vs Finance Lease

Capital leases and finance leases are almost identical in everything but their name. Leases are “finance leases” when they satisfy one of these five criteria:

1. The ownership of an asset transfers to the lessee at the end of the lease term.
2. The lease grants the lessee an option to purchase the underlying asset that the lessee is reasonably certain to exercise. 
3. The leased asset has no alternative use to  the lessor at the end of the lease term.
4. The lease term is a major part of the economic life of the underlying asset (the previous bright line test was 75%)
5. The present value of lease payments is substantially all of the fair value of the leased asset (the previous bright line test was 90%)

From now on, we will be referring to capital leases solely as finance leases, as per the ASC 842 lease accounting standard.

What is the Purpose of a Capital Lease?

The purpose of a finance lease is to allow the lessee to essentially own an asset over the course of the lease contract. Most ownership benefits, as well as the risks, are transferred to the lessee over the course of a finance lease agreement.

Operating leases are another type of lease that have different parameters surrounding them. Read all about capital lease vs operating leases here.

What are the Cons of a Capital Lease?

Since the lessee takes on all the risks of ownership in a finance lease, increased risk is one of the main cons of a finance lease agreement. Additionally, capital lease payments can prove more expensive than just buying an asset outright.

Do We Have to Capitalize Every Lease?

When a lessee makes a policy election to not apply ASC 842 to leases shorter than 12 months, those leases are not capitalized.

LeaseCrunch: Quick, Accurate, White-Glove Lease Accounting

Utilizing LeaseCrunch is an optimal way to make sure your finance leases are in order and correctly documented. Top CPA firms love to use LeaseCrunch for their lease accounting because our software offers:

1. Speed: Our software has a fast implementation time, and performs calculations even faster.
2. Ease of use: Create journal entries and footnote disclosures with just a few clicks.
3. Accuracy and Compliance: Our software has  validation checks to ensure data input accuracy and compliance with standards.
4. Exports into Spreadsheets: What we know is what’s most comfortable. That’s why we offer exports into Excel to give access to the formatting that is best for your business and procedures.

Interested in a quicker and easier lease accounting experience? Contact us today to get started.

FAQS

How do you determine if a lease is a capital Lease?

A lease is a finance lease if it satisfies at least one of the five criteria defined in the ASC 842 lease accounting standard.

Are all leases now finance leases?

No, not all leases qualify as finance leases. 

If leases are out of scope due to short-term criteria or materiality, are they still required to be disclosed in the footnotes?

Leases that are out of scope due to short-term criteria or materiality are still required to be disclosed in footnotes.

What are the four criteria of a capital lease?

Under ASC 840 there were four criteria used to classify leases. Under ASC 842, there are now five criteria used to classify leases. If a lease fits one or more of the five criteria, it’s considered a finance lease.