115 CFA
File: Financial Analysis - Reading 28 - 7. Lease Classification

7. Lease Classification

g. distinguish between a finance lease and an operating lease from the perspectives of the lessor and the lessee;

What is the difference between an operating lease and a capital lease?
- Operating leases (OL) allow the lessee to use the property for only a portion of its economic life.
- Capital leases (CL) involve effective transfer of all risk and benefits of property to the lessee.
- In an operating lease the lessee is not seen as becoming the owner of the asset. In a capital lease the lessee is seen as becoming the owner.

Are operating leases required to be reported on the balance sheet?
The lessee reports only the required lease payments as they are made. There is no balance sheet recognition of the property.

What are the four criteria, any one of which if met would qualify any lease (regardless of how it is classified) to be a capital lease?
1. The lease transfers ownership of the property to the lessee at the end of the term.
2. The lease contains a bargain purchase option that the lessee may purchase the leased asset for a price that is significantly below its fair market value at the end of the lease term.
3. The lease term is equal to 75% or more of the asset's economic life.
4. The present value of the minimum lease payments (MLPs) equals or exceeds 90% of the asset's fair market value, using the lessee's incremental borrowing rate or the implicit rate of the lease.

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