Question

When a lease transaction is to be capitalised, how do we determine the value of the leased asset, and the lease liability?

Answer 1

When a lease transaction is capitalised, then it will be a capital lease. Under capital lease, the lessee becomes the owner of the asset, though legal title may not be transferred to the lessee before the lease term Lessee also claims depreciation on the asset.

. In capital lease transaction, lessee records the lease as an asset and a liability at the lower of :

(a) Fair value of the asset at the beginning of the lease. or

(b) Cost, which is equal to the present value of the minimum lease payments. All other payments that lessee is liable to make are also included in the present value of minimum lease payment calculation. For example, bargain purchase option , guaranteed residual value.etc. Also, while calculating this present value, the lessee uses the lower of the rate implicit in the lease (if known) or lessee's incremental borrowing rate.

Then lessee do the following journal entry to record the lease:

Debit Leased equipment under capital lease

Credit Obligations under capital lease

Periodic lease rentals contain the interest expense and principal repayment. When the lease rentals are paid, then obligations under capital lease are decreased by the principal amount.

At year end, asset is also depreciated.