posted May 19, 2016

To Capitalize or Not to Capitalize….That is the Question

by James Waldrep, CPA, Staff Associate

The District just signed a lease agreement for some new assets and everyone is excited. Brand new equipment, no additional maintenance costs, and, best of all, nothing to put on the Fixed Asset listing! Well, that last part may not be entirely true. Depending on the terms, it is possible the District would need to include the assets on their listing. The terms of the lease are used to determine whether the lease is capital (needs to be included on fixed asset listing) or operating (does not need to be included).

The following comes from GASBS 62, ¶213:

“If at its inception a lease meets one or more of the following four criteria, the lease should be classified as a capital lease by the lessee. Otherwise, it should be classified as an operating lease.

a. The lease transfers ownership of the property to the lessee by the end of the lease term.

b. The lease contains a bargain purchase option.

c. The lease term is equal to 75 percent or more of the estimated economic life of the leased property. However, if the beginning of the lease term falls within the last 25 percent of the total estimated economic life of the leased property, including earlier years of use, this criterion should not be used for purposes of classifying the lease.

d. The present value at the beginning of the lease term of the minimum lease payments, excluding that portion of the payments representing executory costs such as insurance and maintenance to be paid by the lessor, including any gain thereon, equals or exceeds 90 percent of the excess of the fair value of the leased property to the lessor at the inception of the lease over any related investment tax credit retained by and expected to be realized by the lessor….”

Basically what this says is if one of the four above criteria are met, the lease is a capital lease and must be capitalized like a purchased asset. Here are some specific questions that could be helpful in determining proper classification:

  • Will the District own the asset at the end of the lease?
  • Do we have the option to purchase the asset at the end of the lease for an amount other than fair market value?
  • What has historically been the useful life assigned to this type of asset? Is the lease term at least 75% of that?
  • Is the present value of the minimum lease payments at least 90% of the value of the asset?

These questions are not an all-encompassing list but they are a good starting point for determining the proper classification of the lease.

The content of these pages is for general information purposes only and does not constitute advice. Heinfeld, Meech & Co., P.C. tries to provide content that is true and accurate as of the date of writing; however, we give no assurance or warranty regarding the accuracy, timeliness, or applicability of any of the contents.