In this series of posts, we have discussed our churches and ministries can prepare for year-end reporting. In our previous post, we discussed reconciling and closing property, plant and equipment (PP&E) accounts at year-end.
In this post we will determine the characteristics of an operating lease and a capital lease. This will assist you in making sure that all capital lease items are posted as an asset and a liability for the funds owed concerning the lease. See Exhibit D for assistance, too.
Financial Accounting Standards Board (FASB) Statement 13 provides the definitions and criteria for deciding whether or not a lease agreement is to be considered a purchase/sale agreement (and, therefore, a capital lease) or a usage agreement (and, therefore, an operating lease). The distinction between capital and operating leases has important financial consequences: it determines who (lessor or lessee) has ownership rights and who takes depreciation for the leased goods, who can treat lease costs as expenses, and other factors.
For proper explanation of FASB 13 criteria and usage, consult a leasing guide or financial textbook. Very briefly, FASB 13 states that a lease will be considered an operating lease (usage agreement) unless one or more of the following four criteria are met. If any of the following applies, the lease is then treated as a capital lease (purchase/sale agreement):
> The lease automatically transfers ownership of the property to the lessee by the end of the lease.
> The lease contains a bargain purchase option.
> The lease term equals 75% or more of the estimated economic life of the property.
> The present value of the minimum lease payments at the beginning of the lease term equals or exceeds 90% of the fair market value of the property.
In our next post, we will conclude this series by addressing how to record and reconcile prepaid expenses and unrecorded liabilities for entities that report information on the accrual basis.
Posted by Michelle Francis
