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Running head: LEASES
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Leases
ACC306 - Intermediate Accounting II
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Leases
According to our text, regardless of the legal form of the agreement, a lease is accounted for
as either a rental agreement or a purchase/sale accompanied by debt financing depending on the
leasing arrangement. However, I firmly believe that because of the professional judgment that is
needed to differentiate between leases, it is still very easy to misrepresent the truth on a firm’s
balance sheet.
When accounting for leases, an operating lease records no asset or liability on the financial
statements and the amount paid is expensed as it is incurred. On the other hand, a capital lease is
recorded as both an asset and a liability on the financial statements and generally at the present
value of the rental payments. However, individuals and firms can and would abuse the recording
of Operating and Capital Leases for their benefit.
Therefore, the FASB made up specific guidelines that are used to determine the criteria
for Capital Leases. A Capital Lease is non-cancellable and one or more of the following must be
met:
1. The agreement specifies that ownership of the asset transfers to the lessee.
2. The agreement contains a bargain purchase option.
3. The lease term is equal to 75% or more of the expected economic life of the asset.
4. The present value of the minimum lease payments is equal to or greater than 90%
of the fair value of the leased asset (Spiceland, 2007).
On the other hand, a lease is considered to be an Operating lease if the above criteria are
not met. However, firms still use a lot of intentional structuring of lease contracts to avoid
capitalization. Therefore, we must ask the question of “Why do lessees/firm managers want to
avoid putting leased assets and related liabilities on their balance sheets?” (Frecka, 2008). The
answer is very simple:

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Leases ACC306 - Intermediate Accounting II Name Professor Date Leases According to our text, regardless of the legal form of the agreement, a lease is accounted for as either a rental agreement or a purchase/sale accompanied by debt financing depending on the leasing arrangement. However, I firmly believe that because of the professional judgment that is needed to differentiate between leases, it is still very easy to misrepresent the truth on a firm's balance sheet. When accounting for leases, an operating lease records no asset or liability on the financial statements and the amount paid is expensed as it is incurred. On the other hand, a capital lease is recorded as both an asset and a liability on the financial statements and generally at the present value of the rental payments. However, individuals and firms can and would abuse the recording of Operating and Capital Leases for their benefit. Therefore, the FASB made up specific guidelines that are used to determine the criteria for Capital Leases. A Capital Lease is non-cancellable and one or more of the following must be met: 1. The agreement specifies that ownership of the asset transfers to the lessee. 2. The agreement contains a bargain purchase option. 3. The lease term is equal to 75% or more of the expected economic life of the asset. 4. The present value of the minimum lease payments is equal to or greater than 90% of the fair value of the leased asset (Spiceland, 2007). On the other han ...
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