Why do you need to capitalize leased assets?
Believe it or not, leasing is a banking product. Most often, some companies need expensive capital or personal assets to operate, but to own it sometimes requires cash. On a case of a company with good credit, they can own it using credit or through a lease. In leasing, a leaser, the person who provides the cash to pay for the asset, will buy the asset and will provide it to the lessee, the person who will use the asset. The leaser will take into consideration the amount of the asset, taxes, time value of money, and a profit in calculating the monthly lease payment. The lessee will be able to obtain and use the asset without paying full price for the asset.
According to the FASB Financial Accounting Statement no. 13, an accountant must identify if leases should be capitalized by running four tests. If the accountant determines that the asset is a capital lease, the accountant must record the leased asset in their balance sheet, record an interest payment, and depreciate the asset periodically.
A capital asset will pass one of the four test below.
An accountant should be able to read the leasing contract to determine if the asset will be transferred to the lessee from the leaser at the end of the term. If so, it is a capital asset.
2.Option to Buy Test
In reading the contract, an accountant may identify if there is an option to buy the product at the end of the term. If there is such an option, it is a capital lease and the asset should be capitalized.
3.75% Estimated Useful Life Test
When the accountant reads the leasing contract, the accountant can determine the length of the term of the lease. From that number, the accountant must determine the useful life of the asset. The estimated useful life of the asset is available in respectable publication or can be obtained from the manufacturer. It may be sometimes included in the lease contract. Multiply the term of the lease by 75% and if the product is greater than the estimated useful life, it is considered a capital lease.
4.90% Present Value Test
In reading the contract, an accountant can identify any salvage value. If not available, an accountant may also call the manufacturer and determine the salvage value of the asset. Using the salvage value and the monthly lease payment, calculate the present value of the asset using a present value table. Multiply the present value by 90% and if the product is greater than the market value of the asset, it is a capital lease.
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Priscila Santos is a Certified Public Accountant and a Certified Quickbooks Proadvisor in Philadelphia. To contact Priscila for any accounting question, please visit her proadvisor website at proadvisor.intuit.com/quickbooks-help/priscila-santos-cpa or contact her at 215-667-8839.
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