How to Record a Lease for Office Equipment in Journal Entry?
What is a finance lease and how is it different from an operating lease?
Discuss the criteria that must be fulfilled in order to classify a lease as a finance lease.
Answer:
A finance lease is a type of lease where the lessee (the company leasing the asset) essentially assumes all of the risks and rewards of ownership. This type of lease is typically long-term and non-cancellable in nature. The criteria that must be fulfilled in order to classify a lease as a finance lease include:
- The asset will be transferred to the lessee at the end of the lease period
- The agreement must contain a bargain purchase option
- The lease period must be 75% or more of the useful life of the asset
- The present value of the lease payments must be equal to or more than the market value of the asset
Explanation:
A finance lease is essentially a form of financing where the lessee acquires the right to use an asset for an extended period of time. In this type of lease, the lessee assumes the risks and rewards of ownership, which is why it is treated differently from an operating lease.
By meeting the criteria listed above, a lease can be classified as a finance lease. This classification is important as it determines how the lease is accounted for in the financial statements of the lessee.
When recording a finance lease in the journal entry, the lessee would typically debit a lease asset account and credit a lease liability account for the present value of the lease payments. This reflects the lessee's right to use the office equipment for the lease term and the obligation to make lease payments.
It's essential for companies to carefully assess their lease agreements and determine whether they meet the criteria for a finance lease, as this classification can have significant implications for financial reporting and analysis.