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How to account for a capital lease

A capital lease is a contract allowing a renter to use an asset temporarily. This lease shares the same economic characteristics of asset ownership in accounting, as the lease requires book assets and liabilities to cover the lease should the lease contract meet specific criteria.

A lessee must use the capital lease accounting method in their new lease accounting journal entries and subsequent records if the rent contract entered into satisfies any of the four criteria set by the Financial Accounting Standards Board (FASB). Here are the basics of the capital lease accounting method.

What is a Capital Lease?

A capital lease or finance lease is a contract between the business acting as the lessee, and the lessor. The two parties agree that the lessor’s property will be rented out by the business in exchange for periodic rental payments. The business can never claim ownership of the asset and is required to return the said asset to the lessor after the rental period is over.

Under the capital lease accounting, the lessor transfers the rights and risks of owning a rental asset to the business renting the property. Thus, the asset is treated like it has been bought and paid for by a loan. The asset will then be depreciated over the rental period.

Main Differences Between a Capital Lease vs. Operating Lease

An operating lease differs from a capital lease because each follows a different accounting treatment and structure. An operating lease is a contract allowing the renter to use an asset but it does not offer any ownership rights to the lessee.

Operating lease accounting is a one-off recording in the balance sheets. This means that a rented asset and related liabilities of future payments are excluded from the company’s balance sheet so that the ratio of debt to equity is kept low. Traditionally, operating leases helped American companies keep billions of assets and liabilities from being included in their balance sheets.

A lease must meet specific requirements of the generally accepted accounting practices or GAAP to be recorded as an operating lease and exempted from being classified as a capital lease. Firms must assess their contracts using the “bright line” test to determine whether their rental contracts should be booked as operating vs. capital leases.

What are the 4 Criteria for a Capital Lease under ASC 842?

According to ASC 842, there are four tests to determine whether a lease is an operating lease or capital lease. An assessment must be conducted upon signing of the rental contract. Below are the four tests:

  1. Will the ownership or title of the asset be transferred to the renter when the lease term ends?
  2. Is a bargain purchase option available?
  3. Is the lease life equal to or greater than 75 percent of the remaining asset’s economic life?
  4. Is the present value, or PV, of the lease payments equal to or greater than 90 percent of the asset’s fair market value?

A lease is classified as an operating lease if none of the above conditions are met. Otherwise, it can be classified as a capital lease. In some cases, the Internal Revenue Service has reclassified an operating lease as a capital lease, which has resulted in an increase in a firm’s tax liability and taxable income.

What is the Difference Between a Capital Lease vs. Finance Lease?

A capital lease, according to the ASC 842, is now referred to as a finance lease. This is because a large number of rental contracts are now capitalized except for those with a lease term of 12 months or less. The nomenclature capital lease is no longer appropriate, which is why the correct term to use is the finance lease.

Below is an excerpt from ASC 842, defining what a lease is:

Under the lessee accounting model in previous GAAP, the critical determination was whether a lease was a capital lease or an operating lease because lease assets and lease liabilities were recognized only for capital leases. Under Topic 842, the critical determination is whether a contract is or contains a lease because lessees are required to recognize lease assets and lease liabilities for all leases— finance and operating—other than short-term leases (that is, if the entity elects the short-term lease recognition and measurement exemption).

How is a Capital Lease Recorded on the Balance Sheet?

Given the capital lease’s nature of being a financing arrangement, businesses must break down the periodic rental payments into interest expense according to the firm’s applicable depreciation expense and interest rate.

Capital Lease Journal Entry Example

For this capital lease accounting example, say the company makes $1000 in monthly rental payments with an estimated interest of $200. The following should then be entered in the balance sheets:

$1000 credit to the cash account

$200 debit to the interest account

$800 debit to the capital lease liability account

It is important for businesses to depreciate the leased asset to factor in the useful life and salvage value of the asset. In our example, let us assume that the asset still has a useful life of 10 years and zero salvage value using the straight-line basis depreciation treatment. The firm has to record an $833 debit entry to the depreciation expense account monthly and a credit recorded to the accumulated depreciation account. Once the leased asset has been disposed of, then the fixed asset must be credited while the accumulated depreciation account should be debited to reflect the remaining balances.

How Does the Transition to ASC 842 Affect Businesses?

There are changes in lease accounting with the transition from ASC 840 to ASC 842. For example, there is another criterion in determining whether the leased asset should be treated as a capital lease or operating lease. It then becomes imperative for businesses to select a lease accounting software with features reflecting these changes in the GAAP such as our software at Visual Lease.

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Visual Lease Blogs – read about the best lease administration software, lease management solutions, commercial lease accounting software & IFRS 16 introduction.

Capital lease accounting by lessor

In the first part of this article series about capital lease accounting, we discussed accounting for the asset and related liability from the perspective of the lessee. Now we�ll turn to other side of the transaction to look at accounting from the lessor�s perspective.

1. Direct financing leases

If the selling price of the asset equals its cost on the books of the lessor, the lease is a direct financing lease, and the lessor will only realize interest income over the life of the lease. Unlike a sales-type lease, which we�ll describe later, there will be no gain right away.

In the article about capital lease accouting by lessees, we discussed the concept of present value of the lease payments. Lessor accounting utilizes the opposite concept – the exact value of all future lease payments are initially recorded as a lease receivable. In addition, the difference between the lease payments and the asset�s cost is recorded immediately as unearned interest revenue. The unearned account is treated as a contra-receivable. The lessor uses the effective interest method to reduce the unearned interest account over the life of the lease. The receivable is reduced dollar-for-dollar when lease payments are received.

Let�s look at the example from part I again. On January 1, 20X4, Friends Company leases a machine from XYZ Corporation (both fictitious entity) for 10 years. The annual lease payment is $10,000, and the interest rate used by XYZ Corporation for the contract is 8% (see the time value information from part I for this lease). If the asset also has a carrying value of $67,100 for XYZ, the company will account for the lease as a direct financing lease and will record the following journal entry at the beginning of the lease.

A capital lease is a lease in which the lessor only finances the leased asset, and all other rights of ownership transfer to the lessee. This results in the recordation of the asset as the lessee’s property in its general ledger, as a fixed asset. The lessee can only record the interest portion of a capital lease payment as expense, as opposed to the amount of the entire lease payment in the case of the more common operating lease.

Note: The capital lease concept was replaced in Accounting Standards Update 2016-02 (released in 2016 and in effect as of 2019) with the concept of a finance lease. Consequently, the following discussion is for historical purposes only.

Capital Lease Criteria

The criteria for a capital lease can be any one of the following four alternatives:

Ownership. The ownership of the asset is shifted from the lessor to the lessee by the end of the lease period; or

Bargain purchase option. The lessee can buy the asset from the lessor at the end of the lease term for a below-market price; or

Lease term. The period of the lease encompasses at least 75% of the useful life of the asset (and the lease is noncancellable during that time); or

Present value. The present value of the minimum lease payments required under the lease is at least 90% of the fair value of the asset at the inception of the lease.

Accounting for a Capital Lease and Operating Lease

If a lease agreement contains any one of the preceding four criteria, the lessee records it as a capital lease. Otherwise, the lease is recorded as an operating lease. The recordation of these two types of leases is as follows:

Capital lease. The present value of all lease payments is considered to be the cost of the asset, which is recorded as a fixed asset, with an offsetting credit to a capital lease liability account. As each monthly lease payment is made to the lessor, the lessee records a combined reduction in the capital lease liability account and a charge to interest expense. The lessee also records a periodic depreciation charge to gradually reduce the carrying amount of the fixed asset in its accounting records.

Operating lease. Record each lease payment as an expense. There is no other entry.

Given the precise definition of a capital lease, the parties to a lease are usually well aware of the status of their lease arrangement before a lease is signed, and typically write the lease agreement so that the arrangement will be clearly defined as either a capital lease or operating lease.

Navigating unexpected challenges of lease accounting standard

The new lease accounting standard’s focus is, of course, on accounting. But its impacts are not so limited. As US generally accepted accounting principles (GAAP) around leases change, it’s important for CFOs to bring tax leaders to the implementation table so that tax accounting for leases isn’t hindered by new processes and technologies.

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Accounting for leases: The tax impact

The new lease accounting standard, ASC 842, has been on the minds of many CFOs in recent months. Compliance is demanding. Implementation is exacting. Systems are complex.

Preparing for day one is naturally a primary objective for nonpublic entities looking ahead at a 2022 implementation. But thinking beyond that first day of new lease accounting processes is equally important.

You might have processes in place to account for all your leases, but those processes will likely have ripple effects throughout your organization that may not be apparent until well after day one. The implications of the new requirements from the tax perspective will likely be among one of the most significant areas of impact.

While US generally accepted accounting principles (GAAP) rules around lease accounting are changing, the rules governing tax accounting for leases are not. Whether a nonpublic entity preparing for implementation or a postadoption public entity facing this challenge on a business-as-usual basis, it’s crucial that an organization’s tax team adapts to new lease accounting systems and develops new processes to perform the same data extraction they did before the new standard.

It is critical for CFOs to bring their tax teams to the table during implementation of the new lease accounting standard. If implementation is already underway without the tax team’s involvement, CFOs may need to push for having well-documented implementation procedures that tax leaders and other stakeholders outside of accounting can effectively leverage. At the same time, the tax leaders within the organization should be ready to communicate their needs in the new environment and how their work can best be accomplished.

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Reporting Requirements for Annual Financial Reports of State Agencies and Universities

Capitalize a lease if any one of the following criteria is a characteristic of the lease transaction:

  • The lease transfers ownership of the property to the lessee by the end of the lease term.
  • The lease contains a bargain purchase option.
  • The lease term equals 75 percent or more of the estimated economic life of the leased property.
  • The present value of the minimum lease payments at the inception of the lease (excluding executory costs) equals at least 90 percent of the fair value of the leased property.

Leases Involving Land Only

The lessee accounts for a lease involving land as a capital lease if land is the sole item of property leased that meet capital lease criterion (1) or (2). The lessor accounts for a sale-type lease, if the lease:

  • Transfers ownership of the property to the lessee by the end of the lease term
    –AND–
  • Gives profit (loss) to the lessor

A lease involving land is a direct financing lease, if the lease:

  • Transfers ownership of the property to the lessee by the end of the lease term
    –AND–
  • Does not give profit (loss) to the lessor

If the lease contains a bargain purchase option and meets both sale-type and direct financing criteria, the lessor accounts for the lease as a direct financing lease, a leveraged lease or an operating lease.

If the lease does not meet any of the capital lease criterion and the additional criterion below, treat as an operating lease:

  • Collectability of the minimum lease payments is reasonably predictable
  • No important uncertainties

Leases Involving Land and Building(s)

If either criterion (1) or (2) of capital lease is met, the land and building are separately capitalized by the lessee. When the lease meets neither capital lease criterion (1) nor (2) the following is considered:

  • If the fair value of the land is less than 25 percent of the total fair value of the leased property at the inception of the lease, both the lessee and the lessor will consider the land and the building as a single unit for purposes of applying the capital lease criteria (3) and (4).
  • If the fair value of the land is 25 percent or more of the total fair value of the leased property at the inception of the lease, both the lessee and lessor will consider the land and the building separately for purposes of applying the capital lease criteria (3) and (4).

Leases Involving Equipment and Real Estate

If a lease involving real estate also includes equipment, the equipment is:

  • Considered separately for purposes of applying the criteria for classifying leases
    –AND–
  • Accounted for separately according to its classification by both lessees and lessors

Leases Involving Only Part of a Building

If the cost and fair value of the leased property are objectively determinable, both the lessee and the lessor classify and account for the lease according to Leases Involving Land and Building. If not, the lease is classified and accounted for by the lessee as follows:

  • If the fair value of the leased property is objectively determinable, the lessee classifies and accounts for the lease according to Leases Involving Land and Building.
  • If the fair value of the leased property is not objectively determinable, the lessee classifies the lease according to the capital lease criterion (3) only, using the estimated economic life of the building in which the leased premises are located.

If either the cost or the fair value of the property is not objectively determinable, the lessor accounts for the lease as an operating lease.

The accounting topic of leases is a popular Paper F7 exam area that could feature to varying degrees in Questions 2, 3, 4 or 5 of the exam. This topic area is currently covered by IAS 17, Leases. IAS 17, Leases takes the concept of substance over form and applies it to the specific accounting area of leases.

When applying this concept, it is often deemed necessary to account for the substance of a transaction – ie its commercial reality, rather than its strict legal form. In other words, the legal basis of a transaction can be used to hide the true nature of a transaction. It is argued that by applying substance, the financial statements become more reliable and ensure that the lease is faithfully represented.

Why do we need to apply substance to a lease?

A lease agreement is a contract between two parties, the lessor and the lessee. The lessor is the legal owner of the asset, the lessee obtains the right to use the asset in return for rental payments.

Historically, assets that were used but not owned were not shown on the statement of financial position and therefore any associated liability was also left out of the statement – this was known as ‘off balance sheet’ finance and was a way that companies were able to keep their liabilities low, thus distorting gearing and other key financial ratios. This form of accounting did not faithfully represent the transaction. In reality a company often effectively ‘owned’ these assets and ‘owed a liability’.

Under modern day accounting the IASB framework states that an asset is ‘a resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity’ and a liability is ‘a present obligation of the entity arising from past events, the settlement of which is expected to result in an outflow from the entity of resources embodying economic benefits’. These substance-based definitions form the platform for IAS 17, Leases.

So how does IAS 17 work?

IAS 17 states that there are two types of lease, a finance lease and an operating lease. The definitions of these leases are vital and could be required when preparing an answer in the exam.

Finance lease
A finance lease is a lease that transfers substantially all the risks and rewards incidental to ownership of an asset to the lessee.

Operating lease
An operating lease is defined as being any lease other than a finance lease.

Classification of a lease
In order to gain classification of the type of lease you are dealing with, you must first look at the information provided within the scenario and determine if the risks and rewards associated with owning the asset are with the lessee or the lessor. If the risks and rewards lie with the lessee then it is said to be a finance lease, if the lessee does not take on the risks and rewards, then the lease is said to be an operating lease.

Finance lease indicators
There are many risks and rewards outlined within the standard, but for the purpose of the Paper F7 exam there are several important areas. The main reward is where the lessee has the right to use the asset for most of, or all of, its useful economic life. The primary risks are where the lessee pays to insure, maintain and repair the asset.

When the risks and rewards remain with the lessee, the substance is such that even though the lessee is not the legal owner of the asset, the commercial reality is that they have acquired an asset with finance from the leasing company and, therefore, an asset and liability should be recognised.

Other indicators that a lease is a finance lease include:

  • At the inception of the lease the present value of the minimum lease payments* amounts to substantially all of the fair value of the asset
  • The lease agreement transfers ownership of the asset to the lessee by the end of the lease
  • The leased asset is of a specialised nature
  • The lessee has the option to purchase the asset at a price expected to be substantially lower than the fair value at the date the option becomes exercisable

Finance lease accounting

Initial accounting
The initial accounting is that the lessee should capitalise the finance leased asset and set up a lease liability for the value of the asset recognised. The accounting for this will be:
Dr Non-current assets
Cr Finance lease liability
(This should be done by using the lower of the fair value of the asset or the present value of the minimum lease payments*.)
*Note: The present value of the minimum lease payments is essentially the lease payments over the life of the lease discounted to present value – you will either be given this figure in the Paper F7 exam or, if not, use the fair value of the asset. You will not be expected to calculate the minimum lease payments.

Subsequent accounting

Depreciation
Following the initial capitalisation of the leased asset, depreciation should be charged on the asset over the shorter of the lease term or the useful economic life of the asset. The accounting for this will be:

Dr Depreciation expense
Cr Accumulated depreciation

Lease rental/interest
When you look at a lease agreement it should be relatively easy to see that there is a finance cost tied up within the transaction. For example, a company could buy an asset with a useful economic life of four years for $10,000 or lease it for four years paying a rental of $3,000 per annum.

If the leasing option is chosen, over a four-year period the company will have paid $12,000 in total for use of the asset ($3,000 pa x 4 years) – ie the finance charge in this example totals $2,000 (the difference between the total lease cost ($12,000) and the purchase price of the asset ($10,000)).

When a company pays a rental, in effect it is making a capital repayment (ie against the lease obligation) and an interest payment. The impact of this will need to be shown within the financial statements in the form of a finance cost in the statement of profit or loss and a reduction of the outstanding liability in the statement of financial position. In reality there are several ways that this can be done, but the Paper F7 examiner has stated that he will examine the actuarial method only.

The actuarial method of accounting for a finance lease allocates the interest to the period it actually relates to, ie the finance cost is higher when the capital outstanding is greatest, but as the capital gets repaid, interest payments become lower (similar to a repayment mortgage that you may have on your property). To allocate the interest to a specific period you will require the interest rate implicit within the lease agreement – again this will be provided in the exam and you are not required to calculate it.

One of the easiest ways to apply the actuarial method in the exam is to use a leasing table. Please take note of when the rental payment is actually due, is it in advance (ie rental made at beginning of the lease year) or is it in arrears (ie rental made at the end of the lease year)? This will affect the completion of the lease table as highlighted below:

The guidance indicates a company would consider the likelihood of exercising any termination or cancellation clauses at lease commencement, when determining the initial lease term and recording the initial valuation of the lease assets and liabilities. However, subsequent to this determination, there may be circumstances that change the initial determination of whether these options would be exercised, and if so, when.

If the early termination options require prior notice or if a decision to terminate has been agreed upon, this will generally require recalculation of the related lease asset and liability prior to the actual termination date (i.e. the accounting for the termination occurs when the decision is made, versus when the termination event occurs). However, for the purposes of this article the termination and the accounting recognition of the termination occur at the same time.

Full lease termination options broken down by lessee and lessor

The approaches discussed below are applicable for accounting for a full lease termination under ASC 842, IFRS 16, and GASB 87. From the perspective of a lessee, the accounting for the early termination of an operating lease is consistent with that of a finance lease.

Lessee

A full termination will result in the lessee relinquishing the right to use the entire leased asset. This requires the lessee to derecognize the full right-of-use asset and lease liability. Any difference between the balances of the lease asset and liability as of the date of termination will result in a gain or loss recognized on the income statement in the period of termination.

The lessor often stipulates within the agreement that the lessee must pay a penalty upon execution of the termination. If a lease termination penalty is applicable and not previously included in the calculation of lease payments, the lessee will factor such penalty into the gain or loss calculation.

Lessor

From the lessor perspective, a full lease termination also requires lessors to fully derecognize any associated lease assets (i.e. lease receivable) or lease liabilities (i.e. rent receivable, deferred inflow of resources, unamortized initial direct costs, etc.). Any variance between the related assets and liabilities would constitute a gain or loss on the income statement in the period of termination.

In addition to the termination of the leased asset, the arrangement could change such that the usage of the leased asset is reduced. This is accounted for as a partial lease termination. We will address the accounting for a partial termination, and the differences between the treatment within the respective standards, below.

Partial termination options broken down by standard

A partial lease termination occurs when the lessee’s right-of-use asset decreases in utilization (i.e. an organization leases five floors within an office building, then vacates one floor). Most often, lease payment amounts will decrease based on the partial reduction in utility incurred by the lessee. Thus, a partial termination will involve a reduction of the lease liability. We have outlined specific calculations for each standard below:

US GAAP

ASC 842 provides two alternatives to recognize the reduction in the asset. The LeaseQuery system utilizes the approach based on the proportionate adjustment to the lease liability, since a lessee would have this information readily available after calculating the modified liability.

After calculating the modified lease liability, the lessee should adjust the right-of-use asset value by a proportionate amount. For example, if the lease liability decreases by 5% based on the new payment terms, the lessee would calculate a 5% reduction in the right-of-use asset value. Any variance between the adjustment to the asset and the liability should be recorded in current period gain or loss.

IFRS 16 requires the calculation of a modified lease liability, and an adjustment to the asset value to reflect the partial termination with any variance recorded to gain or loss in the current period. LeaseGuru powered by LeaseQuery can provide these calculations needed for IFRS 16 compliance. Try it for free by adding two leases.

GASB 87 requires lessees to remeasure the lease liability and lease asset based on the adjusted payment terms. The lessee will calculate the adjustment to the lease liability and recognize an adjustment of the same amount to the lease asset, with any difference reflected in gain or loss for the current period. For example, if the lease liability decreases by $100 based on the new payment terms, the lessee must decrease the right-of-use asset value by $100. Lessors reporting under GASB 87 will remeasure the deferred inflow of resources, as well as the lease receivable, in the same manner.

Full termination due to purchase

A lease can additionally cease if the lessee purchases the underlying asset from the lessor. As of the purchase date, the lessee would follow the guidance within the respective standard to establish a fixed asset on the balance sheet and remove the intangible right-of-use asset. We have identified the accounting requirements related to purchases as follows:

US GAAP

Under ASC 842 a lease that ends due to the lessee purchasing the underlying asset from the lessor does not constitute a lease termination. Instead, the lease is accounted for as a purchase. The lessee records the new fixed asset value as the carrying value of the leased asset plus or minus an adjustment equal to the difference between the purchase price and the lease liability balance at the time of purchase.

Under IFRS, the exercise of an unplanned purchase option requires a reassessment of our lease liability and corresponding lease asset. Any variances to the asset and liability balances will be recorded as gain or loss.

Under GASB 87, as of the purchase date, the lessee would reclassify the intangible right-of-use asset to a fixed asset.

Because there are various options to terminate a lease, it’s important to understand the accounting treatment of an early termination under the respective new standard. While the information above helps outline what you need to know about lease termination options, implementing a lease accounting solution that handles termination scenarios will allow your company to account for these situations effortlessly and accurately.

Try LeaseGuru for free for ASC 842 & IFRS 16 compliance

If you’re a small business reporting under FASB or IASB standards, LeaseGuru powered by LeaseQuery might be the right lease accounting solution for you. LeaseGuru makes it simple and secure to account for up to 15 leases under ASC 840, ASC 842, and IFRS 16. Plus, it’s completely free to try. Create your free account to get started with journal entries, amortization schedules and more.

How to account for a capital lease

11 Aug Capital v. Operating Lease – Tax Reporting Implications

We often encounter taxpayers who do not quite fully understand how to report for income tax purposes the lease agreements they have entered into for business use assets, particularly automobiles. Leased property includes real estate, machinery, and other items that a taxpayer uses in his or her business and does not own.

Payments for the use of this property may be deducted as long as they are ordinary, necessary and reasonable. However, special rules and limitations apply to business use of the taxpayer’s rented personal residence and leased automobiles. More information on these topics can be found in:

This post is intended to provide a general overview on how to record and report capital leases v. operating leases. It also briefly addresses growing concerns of related party lease transactions between Private Foundations and ‘disqualified individuals.’

A capital lease generally is a lease in which the lessor only finances the leased asset, and all other rights of ownership transfer to the lessee. This results in recording the asset as the lessee’s property in its general ledger, as a fixed asset.

The lessee can generally only record the interest portion of a capital lease payment as expense, as opposed to the amount of the entire lease payment in the case of the more common operating lease. The criteria for a capital lease can be any one of the following four alternatives:

  • Ownership – The ownership of the asset is shifted from the lessor to the lessee by the end of the lease period; or
  • Bargain purchase option – The lessee can buy the asset from the lessor at the end of the lease term for a below-market price; or
  • Lease term – The period of the lease encompasses at least 75% of the useful life of the asset (and the lease is non-cancel-able during that time); or
  • Present value – The present value of the minimum lease payments required under the lease is at least 90% of the fair value of the asset at the inception of the lease.

If a lease agreement contains any one of the above four criteria, the lessee records the transaction as a capital lease. Otherwise, the lease is recorded as an operating lease. Recording of these two types of leases is as follows.

  • The present value of all lease payments is considered to be the cost of the asset, which is recorded as a fixed asset, with an offsetting credit to a capital lease liability account.
  • As each monthly lease payment is made to the lessor, the lessee records a combined reduction in the capital lease liability account and a charge to interest expense.
  • The lessee also records a periodic depreciation charge to gradually reduce the carrying amount of the fixed asset in its accounting records.
  • Record each lease payment as an expense. There is no other entry.

Given the precise definition of a capital lease, the parties to a lease are usually well aware of the status of their lease arrangement before a lease is signed, and typically write the lease agreement so that the arrangement will be clearly defined as either a capital lease or operating lease.

If you are unsure, review the actual signed lease documents as getting this wrong gives opportunity to the authorities to expand the scope of their scrutiny.

Also if you happen to be involved with a Private Foundation be sure to recognize if you are a disqualified person. Be advised that the leasing of property between a disqualified person and a private foundation is an act of self-dealing.

There are exceptions to the Self-Dealing rules that will get attention in a future post.

General rule of thumb – don’t be like a moth is to a flame.

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Reporting Requirements for Annual Financial Reports of State Agencies and Universities

Disclose if your agency entered into long-term leases of certain capital assets and if such leases are classified as capital leases for accounting purposes. These are recorded at the present value of the future minimum lease payments at the inception of the lease. The required disclosures are:

  • General leasing arrangements.
  • Amount of assets and liabilities recorded under capital leases presented by asset categories. Report governmental activities, business-type activities, discretely presented component units and fiduciary funds separately.
  • Minimum future lease payments (debt service requirements) for each of the next five years (and in five-year increments thereafter) and a grand total showing a deduction for the amount of interest to reduce the net minimum future lease payments to their present value. Disclose principal and interest payments in separate columns.

Note: Use the LNSS web application to enter the capital lease debt service requirements. Use the data from the Capital Leases Debt Service Report generated from the LNSS web application to create the required disclosure in Note 8. This information is populated in the LTLN web application.

  • Total of minimum sublease rentals to be received in the future under noncancelable subleases.
  • Total contingent rentals actually incurred.
  • Separately identify capital assets and accumulated depreciation recorded under capital leases.

In addition to these disclosures, provide a general description of the lease agreement, including items such as the existence of renewal or purchase options and restrictions imposed by the lease agreement.

WARNING: Beginning balances must be the same as the prior year’s ending balances. Beginning balances are populated in the LTLN web application. Ending balances must tie to the combined balance sheet amount in the long-term liabilities adjustments for the line item “capital lease obligations.”

For more information on how to disclose capital lease – direct borrowings and/or direct placements see Direct Borrowings and Direct Placements.