When recording a capital lease with a bargain purchase option, you first need to determine whether the lease meets the criteria to be classified as a capital lease. A capital lease is a lease that transfers substantially all the risks and rewards of ownership to the lessee. If the lease meets these criteria and includes a bargain purchase option, it should be recorded on the lessee’s books as both an asset and a liability.
**Here’s how you can record a capital lease with a bargain purchase option:**
1. **Initial Recognition**: The lessee should recognize the leased asset and the lease liability at the lower of the present value of minimum lease payments or the fair value of the leased asset at the inception of the lease.
2. **Calculating Present Value**: Calculate the present value of minimum lease payments using the interest rate implicit in the lease, if known. If the interest rate is not known, use the lessee’s incremental borrowing rate.
3. **Recording the Asset**: Record the leased asset at the present value of minimum lease payments, discounted at the implicit interest rate or incremental borrowing rate.
4. **Recording the Liability**: Record the lease liability at the same amount as the leased asset. The lease liability should be reduced over time as lease payments are made.
5. **Recording Depreciation**: Depreciate the leased asset over its useful life, just like any other fixed asset.
6. **Recording Interest Expense**: Record interest expense on the lease liability each period. The interest expense is calculated based on the lease liability balance and the interest rate.
7. **Recording Bargain Purchase Option**: If the lease includes a bargain purchase option, the present value of the option should be added to the lease liability and asset at the inception of the lease.
8. **Annual Adjustments**: Make annual adjustments to the lease liability and asset based on the interest expense and lease payments made during the year.
9. **Assessing Impairment**: Regularly assess the leased asset for impairment, just like any other fixed asset.
10. **Disclosure**: Make sure to disclose all relevant information about the capital lease in the financial statements, including the nature of the lease, lease payments, and any contingent rent payments.
11. **Periodic Reassessment**: Reassess the lease liability and asset if there are any changes to the terms of the lease, such as exercising the bargain purchase option.
12. **Transitioning to ASU 2016-02 (Topic 842)**: Be aware of the new lease accounting standard, which requires lessees to recognize most leases on their balance sheets. Make sure to follow the new guidelines when recording capital leases with bargain purchase options.
FAQs
1. What is a capital lease with a bargain purchase option?
A capital lease with a bargain purchase option is a lease that transfers substantially all the risks and rewards of ownership to the lessee and includes an option to purchase the leased asset at a price significantly below its fair value.
2. How is a capital lease different from an operating lease?
A capital lease transfers ownership of the asset to the lessee at the end of the lease term, while an operating lease does not transfer ownership and is treated as a rental agreement.
3. What factors determine whether a lease is a capital lease?
Factors such as the transfer of ownership, bargain purchase options, lease terms, and present value of minimum lease payments relative to the fair value of the asset determine whether a lease should be classified as a capital lease.
4. How do you calculate the present value of minimum lease payments?
The present value of minimum lease payments is calculated by discounting the future lease payments using the interest rate implicit in the lease, if known. Otherwise, the lessee’s incremental borrowing rate should be used.
5. What is the impact of a bargain purchase option on a capital lease?
A bargain purchase option lowers the present value of minimum lease payments, which affects the initial recognition of the leased asset and lease liability on the lessee’s balance sheet.
6. Can a lessee record a capital lease with a bargain purchase option as an expense?
No, a capital lease should be recorded as an asset and a liability on the lessee’s balance sheet, with lease payments being allocated between principal and interest.
7. How does a lessee account for depreciation on a capital lease with a bargain purchase option?
Depreciation on a capital lease is similar to depreciation on any other fixed asset, where the leased asset is depreciated over its useful life.
8. What are the disclosure requirements for a capital lease with a bargain purchase option?
The lessee should disclose all relevant information about the lease in the financial statements, including the nature of the lease, lease payments, and any contingent rent payments.
9. Can a lessee reassess the terms of a capital lease with a bargain purchase option?
Yes, a lessee should reassess the lease liability and asset if there are any changes to the terms of the lease, such as exercising the bargain purchase option.
10. What is ASU 2016-02 (Topic 842) and how does it affect lease accounting?
ASU 2016-02 is a new lease accounting standard that requires lessees to recognize most leases on their balance sheets. Lessees should follow the new guidelines when recording capital leases with bargain purchase options.
11. When should a lessee assess the leased asset for impairment?
A lessee should regularly assess the leased asset for impairment, just like any other fixed asset, to ensure that the carrying amount does not exceed the recoverable amount.
12. How does a lessee adjust the lease liability and asset for a capital lease with a bargain purchase option?
The lessee should make annual adjustments to the lease liability and asset based on the interest expense and lease payments made during the year. This helps ensure that the lease is properly accounted for on the balance sheet.