FASB 13 provides criteria to classify leases into which two accounting categories?

FASB 13 provides criteria to classify leases into which two accounting categories?

• A. Liquidity vs solvency
• B. Capital vs operating
• C. Tax vs non-tax
• D. Finance vs service

Answer: (B)

Leases are classified under FASB 13 into two categories: capital (finance) leases and operating leases. This distinction matters because it determines how the lessee accounts for the lease on the financial statements. In a capital (finance) lease, the lease effectively transfers ownership risks and rewards to the lessee. The lessee records a leased asset and a corresponding lease liability at the outset, depreciates the asset, and recognizes interest expense on the liability over the lease term. This mirrors buying the asset with a financed arrangement. In an operating lease, the lessee does not recognize the leased asset or the lease liability on the balance sheet (in the traditional framework). Lease payments are expensed over the term, typically on a straight-line basis, like a rental expense. FASB 13 provides criteria to distinguish these two paths, including factors such as whether ownership transfers, whether there is a bargain purchase option, the lease term relative to the asset’s economic life, and the present value of minimum lease payments relative to the asset’s fair value. If those criteria indicate transfer of ownership or substantial financing of the asset, it’s classified as a capital (finance) lease; otherwise, it’s an operating lease. Note: modern standards have evolved, but under FASB 13 the two categories used were capital (finance) and operating.

Leases are classified under FASB 13 into two categories: capital (finance) leases and operating leases. This distinction matters because it determines how the lessee accounts for the lease on the financial statements.

In a capital (finance) lease, the lease effectively transfers ownership risks and rewards to the lessee. The lessee records a leased asset and a corresponding lease liability at the outset, depreciates the asset, and recognizes interest expense on the liability over the lease term. This mirrors buying the asset with a financed arrangement.

In an operating lease, the lessee does not recognize the leased asset or the lease liability on the balance sheet (in the traditional framework). Lease payments are expensed over the term, typically on a straight-line basis, like a rental expense.

FASB 13 provides criteria to distinguish these two paths, including factors such as whether ownership transfers, whether there is a bargain purchase option, the lease term relative to the asset’s economic life, and the present value of minimum lease payments relative to the asset’s fair value. If those criteria indicate transfer of ownership or substantial financing of the asset, it’s classified as a capital (finance) lease; otherwise, it’s an operating lease.

Note: modern standards have evolved, but under FASB 13 the two categories used were capital (finance) and operating.