Fixed-term (and usually non-cancelable)
lease that is similar to a
loan agreement for
purchase of a
capital asset on installments. The lessor's
services are
limited to
financing the
asset, the
lessee pays all
other costs including
insurance,
maintenance, and taxes. Capital leases are regarded as essentially-equivalent to a
sale by the
lessor, and a purchase by the lessee (even though the
title remains with the lessor). Therefore, leased assets must be capitalized and shown in the lessee's
balance sheet as a
fixed asset with a corresponding
non-current liability (lease payable). The lessee acquires all the economic benefits (such as depreciation) and risks (such as the possibility of the loss of the leased asset) of
ownership but can
claim only the interest-portion (not the entire amount) of the
lease payment as an
expense.
To be considered a capital lease, a lease must meet one or more of these four criteria: (1) title of the asset passes
automatically from the lessor to the lessee at end of the
lease term, (2) lease contains a
bargain purchase option under which the lessee may acquire the leased-asset at less than its fair market value at the end of lease term, (3) lease term is for a
period longer than the 75
percent of the estimated
economic life of the asset, or (4) the present value of the lease payments is greater than 90 percent of the fair market value of the asset at the beginning of the lease term. A capital lease is a 'full payment lease' because the lease payments pay back (amortize) the
full cost (including financing costs, overheads, and profit margin) of the leased asset to the lessor, with little or no
dependence on the
residual (or salvage) value of the asset. Called also
finance lease or
financial lease. See also
operating lease and
sale and leaseback.