Transaction as a Capital Lease

Note in each of these criteria the rationale for classifying the transaction as a capital lease.

1. The lease contract specifies that title to the property will be conveyed to the lessee by the end of the lease

term. If legal ownership is to be transferred from lessor to lessee, the entire series of payments is simply a

method devised to purchase the asset. In substance, the agreement was never intended to be a rental. From

the beginning, the property was being acquired.

2. The lease contract allows the lessee to buy the property at a specified time at an amount sufficiently

below its expected fair value so that purchase is reasonably assured. The availability of this bargain

purchase option indicates, once again, that the true intention of the contract is the conveyance of ownership.

The transaction is the equivalent of a purchase if the option price is so low that purchase by the lessee can

be anticipated.

3. The lease contract is for a term that is equal to 75 percent or more of the estimated life of the property.

This criterion is different from the first two where the transaction was just a disguised purchased. Here, the

lessee will never gain ownership. However, the lease is for such an extensive portion of the asset’s life that

the lessee obtains a vast majority of its utility. Although the 75 percent standard is an arbitrary benchmark,

no doubt can exist that the lessee will be the primary beneficiary of the value of the property.

4. The fourth criterion is too complicated to cover in an introductory textbook. The general idea is that the

lessee is paying approximately the same amount as would have been charged just to buy the asset. Paying

the equivalent of the purchase price (or close to it) indicates that no real difference exists between the nature

of the lease transaction and an acquisition.

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