Definition

Capital leases

Capital lease is a contractual arrangement that transfers substantially all the benefits and risks of ownership to the lessee so that the lease is in effect a purchase of the property.

In most lease contracts, the lessee makes a periodic payment and records that payment in the income statement as rent expense. In some cases, however, the lease contract transfers to the lessee substantially all the benefits and risks-of ownership. Such a lease is in effect a purchase of the property. This type of lease is a capital lease. Its name comes from the fact that the company capitalizes the present value of the cash payments for the lease the records that amount as an asset.

A capital lease situation is one that, although legally a rental case, is in substance an installment purchase by the lessee. Accounting standards require that substance over form be used in such a situation.

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