Capital-lease Definition

A lease that in an economically substantial way transfers nearly all of the risk and rewards inherent in the leased property to the lessee. Payments for a capital lease should not be treated as a current expense, but rather should be capitalized by recording them on the balance sheet as both an asset and a liability. Under the “Statement of Financial Accounting Standards 13” criteria, a lease must be treated as a capital lease if it meets one of the following four criteria: (1) the lease transfers ownership of the property to the lessee when the lease ends; (2) the lease has a purchase option at a price discounted from the regular market price; (3) the length of the lease is equal to 75 percent of the estimated economic life of the leased property, although this isn’t applicable if the lease term begins during the final 25 percent of the estimated economic life; and (4) the present value of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased property. A capital lease contrasts with an operating lease, which does not meet any of those four criteria. An operating lease is an expense item and no asset or liability is recorded on the company’s financial statements.
Webster's New World Finance

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