What to expect:
- What is a capital lease? What are the criteria?
-What are strong and weak forms?
-Examples
-links to downloadable/free accounting tools
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Major Difference
between Strong
and Weak-Form
In a strong-form lease, the
underlying assets are
depreciated over the useful life
of the asset as if it were owned
while for weak-form leases the
assets are depreciated over the
lease term
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Example
Use our free tool to help
determine if this is a Capital
or Operating lease
● Useful life of the forklift is 5 years
● At the end of the lease term, the
company can purchase the forklift for
$1,000, which is the estimated fair
value at the end of the lease.
Assume a company (lessee) signs a lease for
a forklift with the following predicates:
● Fair value of the forklift is $16,000
● Lease term is 3 years
● Monthly payments of $500/month paid
in advance; $50 of the monthly payment
is related to maintenance
● Interest rate a bank would charge this
company for a $16,000 loan over 3 years
is 4%
Free Tool
(click me)
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Capital vs Operating Lease Test
● At the end of the lease term, the
company can purchase the forklift for
$1,000, which is the estimated fair
value at the end of the lease.
● The above information answers no to
both criterion one and two, therefore
this is not a strong-form capital lease
and we must continue testing
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Capital vs Operating Lease Test
● Lease term is 3 years
● Useful life of the forklift is 5 years
● Monthly payments of $500/month paid in
advance; $50 of the monthly payment is related
to maintenance
● **NOTE** Use payment of $450 instead of
$500 because $50 of the payment is related to
maintenance and deemed “executory cost”
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Capital vs Operating Lease Test
● After submitting all of the
information; open the PDF summary
to see the results
● As you can see, we have a capital
lease because of the fourth test
which shows that the present value
of the minimum lease payments are
greater than or equal to 90% of
fair value of the asset
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Journal Entries To Be Recorded
● To record the initial value of the lease, we
need the present value of the minimum
lease payment
● In the Free Tools section of our site;
download the Present Value Calculation
Tool to compute PV of the minimum lease
payments.
● Enter the appropriate data and refresh the
sheet to see amount to be booked, the
entry will look like below:
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Journal Entries To Be Recorded
● Two entries need to be recorded monthly
● The first entry will be to reduce the Capital
Lease Liability, book Maintenance
Expense, and record Cash Payment.
● Because the first cash payment is made at
the beginning of the lease term, there is no
interest to be recorded(1A), the subsequent
month’s entry will look like the second entry
shaded light blue(2A)
1A:
2A:
Monthly Entry 1:
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Journal Entries To Be Recorded
● The second entry to be made monthly will be
Depreciation Expense, which is straight lined
from the present value of the minimum lease
payments over the term of the lease
● 15,293 ➗ 36 Months = 424.80
● **Note** This lease is a weak-form capital
lease which means we depreciate over the
term of the lease(36 months) instead of
useful life(60 months)
Monthly Entry 2:
