A capital lease is a lease in which the lessor only finances the lease, and all other rights of ownership transfer to the lessee, resulting in the recording of the underlying asset as the lessee's property in its general ledger. The lessee can only record the interest portion of a capital lease payment as expense, as opposed to the amount of the entire lease payment in the case of a normal lease.The accounting for a capital lease involves the following steps:
- Recognize capital lease. If a lease meets several criteria needed to qualify for accounting as a capital lease, then record the present value of all lease payments as the cost of the underlying asset.
- Record interest expense. As the lessee makes lease payments to the lessor, record a portion of each payment as interest expense.
- Capital lease depreciation. The lessee calculates and records depreciation expense for the recognized amount of the asset. This can be a straight-line or some type of accelerated method of depreciation. The useful life for the depreciation calculation is typically the period over which lease payments are made.
- Dispose of asset. Once the lessee disposes of the asset at the end of its useful life, reverse the asset and accumulated depreciation accounts, and recognize any gain or loss on the disposal transaction.