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For a capital lease, the FASB has identified four criteria.
1. Lease transfers ownership of the property to the lessee.
2. Lease contains a bargain-purchase option.
3. Lease term is equal to 75 percent or more of the estimated economic life of the leased property.
4. The present value of the minimum lease payments (excluding executory costs) equals or exceeds 90 percent of the fair value of the leased property.
**** Leases that DO NOT meet any of the four criteria are accounted for as Operating Leases.
Capitalization Criteria
Transfer of Ownership Test
 Not controversial and easily implemented.
Bargain-Purchase Option Test
 At the inception of the lease, the difference between the option price and the expected fair market value must be large enough to make exercise of the option reasonably assured.
Economic Life Test (75% Test)
 Lease term is generally considered to be the fixed, noncancelable term of the lease.
 Bargain-renewal option can extend this period.
 At the inception of the lease, the difference between the renewal rental and the expected fair rental must be great enough to make exercise of the option to renew reasonably assured.
 Recovery of Investment Test (90% Test)
Minimum Lease Payments:
 Minimum rental payment
 Guaranteed residual value
 Penalty for failure to renew or extend the lease
 Bargain-purchase option
Executory Costs:
 Insurance
 Maintenance
 Taxes
Exclude from PV of Minimum Lease Payment Calculation
Sales-Type Leases (Lessor)
 Primary difference between a direct-financing lease and a sales-type lease is the manufacturer’s or dealer’s gross profit (or loss).
 Lessor records the sale price of the asset, the cost of goods sold and related inventory reduction, and the lease receivable.
 Difference in accounting for guaranteed and unguaranteed residual values.

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