Definition:
A capital lease is a type of lease agreement where the lessee (the party using the asset) acquires substantially all of the risks and rewards of ownership of the leased asset. It’s essentially a form of financing where the lessee is treated as the owner of the asset for accounting purposes.
Key characteristics of capital leases:
- Ownership transfer: The lessee acquires substantially all of the risks and rewards of ownership.
- Transfer of title: The lease agreement may include a transfer of title to the lessee at the end of the lease term.
- Purchase option: The lessee may have the option to purchase the asset at a bargain price at the end of the lease term.
- Present value: The present value of the minimum lease payments is equal to or greater than the fair market value of the asset.
Why are capital leases used?
- Off-balance sheet financing: Capital leases can be used to off-balance sheet financing, as the asset and related liability are not recorded on the balance sheet of the lessee.
- Tax benefits: In some cases, capital leases can offer tax benefits to the lessee.
- Asset acquisition: Capital leases can be a way for lessees to acquire the use of an asset without having to purchase it outright.
However, it’s important to note that capital leases can have a significant impact on a company’s financial statements and cash flow.
In essence, a capital lease is a type of lease agreement where the lessee acquires substantially all of the risks and rewards of ownership of the leased asset, and it’s a form of financing that can be used to acquire the use of an asset without having to purchase it outright.
