Which statement describes a capital lease?

Which statement describes a capital lease?

• A. Trigers FASB 13; aka Finance Agreement
• B. All tax benefits accrue to lessee only
• C. It is a true tax lease
• D. Assets are never depreciated

Answer: (A)

A capital lease (also called a finance lease) is treated as a financing arrangement, not just a rental. Under FASB 13, the lessee must recognize both an asset and a corresponding liability at the lease’s inception. The asset is then depreciated over its useful life, and the lease payments are split into interest expense and principal reduction on the liability. This is why a capital lease is described as an on-balance-sheet financing arrangement rather than a simple operating lease. The statement that this describes a capital lease is best because it captures the essential accounting treatment: capitalization on the balance sheet, depreciation of the asset by the lessee, and interest recognition on the lease obligation. The other statements don’t fit. A capital lease is not defined by being a “true tax lease,” since tax treatment can vary and isn’t what determines the classification. And in a capital lease, assets are indeed depreciated by the lessee, so saying they are never depreciated is incorrect.

A capital lease (also called a finance lease) is treated as a financing arrangement, not just a rental. Under FASB 13, the lessee must recognize both an asset and a corresponding liability at the lease’s inception. The asset is then depreciated over its useful life, and the lease payments are split into interest expense and principal reduction on the liability. This is why a capital lease is described as an on-balance-sheet financing arrangement rather than a simple operating lease.

The statement that this describes a capital lease is best because it captures the essential accounting treatment: capitalization on the balance sheet, depreciation of the asset by the lessee, and interest recognition on the lease obligation.

The other statements don’t fit. A capital lease is not defined by being a “true tax lease,” since tax treatment can vary and isn’t what determines the classification. And in a capital lease, assets are indeed depreciated by the lessee, so saying they are never depreciated is incorrect.