Which statement describes what happens when a capital lease criterion is met?

Which statement describes what happens when a capital lease criterion is met?

• A. It requires capital lease treatment if any criterion is met
• B. It is automatically an operating lease
• C. It is always a sale-type lease
• D. It is not allowed to classify as a lease

Answer: (A)

When any one of the capital lease criteria is met, the lease is accounted for as a capital (finance) lease. For the lessee, this means recording a right-of-use asset and a corresponding lease liability at the present value of the minimum lease payments, then depreciating the asset and recognizing interest expense on the liability over the term of the lease. The four criteria are ownership transfer by the end of the term, a bargain purchase option, the lease term covering a major part of the asset’s economic life, or the present value of the minimum lease payments equaling or exceeding substantially all of the asset’s fair value. If any one of these is met, capitalization is required, not operating-lease treatment. The other statements aren’t correct because a capital-lease criterion does not make it an operating lease, nor does it imply it’s always a sale-type lease from the lessee perspective, and it is indeed possible to classify a lease as a lease when capitalization criteria are met.

When any one of the capital lease criteria is met, the lease is accounted for as a capital (finance) lease. For the lessee, this means recording a right-of-use asset and a corresponding lease liability at the present value of the minimum lease payments, then depreciating the asset and recognizing interest expense on the liability over the term of the lease. The four criteria are ownership transfer by the end of the term, a bargain purchase option, the lease term covering a major part of the asset’s economic life, or the present value of the minimum lease payments equaling or exceeding substantially all of the asset’s fair value. If any one of these is met, capitalization is required, not operating-lease treatment.

The other statements aren’t correct because a capital-lease criterion does not make it an operating lease, nor does it imply it’s always a sale-type lease from the lessee perspective, and it is indeed possible to classify a lease as a lease when capitalization criteria are met.