Capital lease accounting – understanding the components of the concept

finance lease accounting

Last Updated on August 12, 2022 by

Capital lease accounting is the concept which deals with several kinds of conditions. Under it, the life of the lease exceeds approximately 75% of the life of the assets and the transfer of ownership of the assets to the lessee is done at the end of the time of lease. So, when the agreement meets all these kinds of conditions then it can be very effectively termed as the capital lease. 

Following are some of the advantages of the capital leased to the lessee: 

-It comes with ownership related benefits: The capital lease always comes with benefits because the lessee, in the end, can very easily purchase the least asset. The lease can be utilized for approximately than 75% of its life. Hence, at the end of the whole term, the lessee will get an option to purchase the assets at a base and price. So, the whole concept comes with ownership related advantages to the Lessee. There will be a complete Transfer of ownership rights to the Lessee and the Lessee can very easily show the leased assets in their balance sheet so that the depreciation can be claimed. Hence, the depreciation is an expense which will reduce the profit of the company which will ultimately help in reducing the tax liability. 

– It is a direct claim to the interest expense: The Lessee is not paying for the asset but the payment will be done by the lesser. So, over and above the principle the lesser will always charge interest for the money which he has invested into the assets. Hence when the Lessee will be paying interest then he can very easily show the interest expenses as the expenses into his income statement which will reduce his profit and ultimately the tax liability will be significantly reduced. 

-The concept provides cost-related benefits: Whenever any of the company wants to buy an asset on lease and does not has the cash then they can go with the option of raising the funds or bank loan. But to deal with all these kinds of issues capital lease is the best possible option because the lesser funds the assets in the capital list at the rate of interest of this particular lease is comparatively lower to the bank loan. Hence, it helps to provide several kinds of cost-related benefits very easily.   

-It is a good risk-return balance on investment for the lesser: Whenever any of the lesser will get into capital lease agreement the main motivation will be to make money. Hence, the lesser are normally the companies which have a lot of cash so that they can make good use of it through the best investments. A capital lease is considered to be the best possible investment option because it has to provide a good amount of return in comparison to other instruments for example commercial papers and debentures. On the other hand, the risk is very low and it is a good form of investment because it is a thing which provides good risk-return balance. 

Hence, finance lease accounting has to be undertaken very well so that all the records of the capital lease can be maintained very easily and all the benefits associated with it can be availed. 

Read More: What is the Difference: Finance Lease versus Operating Lease?