A description of how the accounting works for a “contract of sale” purchase, a capital lease, and an operating lease can be found in my article “Loans vs. Leases: What’s it all about?” But to give you an idea of what I am referring to, let me ask a question. Have you ever leased a piece of equipment where at the end of the lease term you had the option to purchase the item for $1.00 or some other ridiculously small amount?
If so, you should have treated that lease the same way you would have treated a normal purchase of equipment in your accounting records. In other words, the lease should have been capitaized. The equipment item should have been recorded in the Fixed Assets section of the Balance Sheet as a debit, and the down payment a credit to Cash, and the remaining balance owed set up as a Capital Lease or Lease Obligation in the liability section of the Balance Sheet. Interest and depreciation should be expensed as with any other purchase of an asset that has an installment loan associated with it.
It is important to understand what constitutes a “true” lease from a “dirty” lease (a capital lease). The accounting requirements are very different. Read the article and let me know if you have any questions.
John Day
10 Comments
Hey,
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Darren
You have nicely explained loans vs leases.
I have described the difference between the experience and professional in my above blog. I need your comments please
Innova: I’m sorry, but the primary purpose of this blog is for people to ask accounting questions related to small business. I’m willing to give my time to respond to only those kind of needs.
This is one of the greatest blogs I’ve ever seen in relation to accounting. Informative, knowledgeable and insightful view. Keep up the good work, dude!!
Regards,
Accounting & Auditing Blog
http://myauditing.blogspot.com
Very INFORMATIVE and WELL said.. I suggest Accounting students to practice solving problems and use Accounting software to check if they got it right.
Thanks for providing such great information about accounting services and more. Great! Keep us updated.
accountant Ontario
I am needing help with leased buildings (by the leasee). Should a leased build be accounted for an asset? or a liability? How are the payments handled from a tax perspective? An example would be a man starting a small business and leasing a building for 10 years for one cost per year,with no purchase option at the end of the 10 years.
This is very confusing to me, please help! Thanks
Casey: You have a “true lease”, therefore record your lease payments to the general ledger account “Rent” in your operating expense section as a debit. You don’t own the building so it is not an asset of the company. Since it is not a lease option to eventually own the building it is not a contract of sale so there is no “lease obligation” liability account to set up.
John
Nice Post. Hope to know more.
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