Capital Lease

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DEFINITION of 'Capital Lease'

A lease considered to have the economic characteristics of asset ownership. A capital lease would be considered a purchased asset for accounting purposes. An operating lease, on the other hand, would be handled as a true lease, or rental, for accounting purposes. The choice of lease classification will have important results on a firm's financial statements. A lease falls into this category if any of the following requirements are met:

1. The life of the lease is 75% or greater of the assets useful life.

2. The lease contains a purchase agreement for less than market value.

3. The lessee gains ownership at the end of the lease period.

4. The present value of lease payments is greater than 90% of the asset's market value.

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BREAKING DOWN 'Capital Lease'

A capital lease is an example of accrual accounting's inclusion of economic events. Generally, companies have a choice of which type of lease they wish to use for accounting purposes, however, both types of leases provide specific advantages and disadvantages to financial statements. For example, companies wishing to show a higher return on asset ratios would choose an operating lease, as the balance sheet would not account for the item as an asset, thus reducing the denominator in the ratio.

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