Financial Analysis: Capital Lease vs. Operating Lease Case Study

This assignment presents a case study analyzing the classification of a lease as either a capital lease or an operating lease. The scenario involves a lease agreement with a bargain purchase option. The solution explains that the lease should be classified as a capital lease due to the presence of the bargain purchase option, where the lessee can purchase the asset at a price significantly lower than its market value at the end of the lease term. The assignment highlights the ethical considerations involved in different accounting treatments and references Generally Accepted Accounting Principles (GAAP) to support the classification. The solution also includes references to relevant sources that support the analysis.

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ACCOUNTING

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A capital lease is the else wherein the lessor is the party that goes on to finance the asset
that has been leased and all of the other rights that are associated with the ownership of
that rests with the lessee. This results in the recording of the asset since the property of
the lease in the case of the capital lease would be reported as a fixed asset. The lessee is
able to record the portion of the interest as the payment of the capital lease as an
expense. This is contrary to the entire amount of the payment of the lease.
The lease shall be classified as the capital lease if any one of the following conditions
are satisfied:
 In respect of the ownership of the asset, the same shifts from the lessor to the
lessee when the period of the lease ends
 There is a bargain purchase option in which the lessee shall buy that asset from
the lessor when the term of the lease ends and the market price of that asset shall
be below the more the price at which the same is being given to the lessee
(Vaidya, 2019).
 The term of the lease constitutes to about 75% of the total number of useful lives
of the asset
 The present value of all of the minimum payments of lease being made by the
lessee shall constitute to about 90% of the total amount of the fair value of the
asset.
In case, any one of the above stated condition is met, then the lease would be considered
to be a capital else, otherwise operating lease.
In the given case, the following are the conditions that holds:

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 There is a bargain purchase option available with the lessee
 After the term of the lease which is 3 years, the lessee shall be able to buy the
asset which is the laser tech machine at the value of $ 500 whereas the market
price of the same is $850.
 The market value of $500 shall be immaterial for the purposes of making the
above stated decision.
Ethical issue:
There is an ethical issue involved since both of the leases have different methods of
being recorded in the books of accounts.
Correct option:
Since, there is an involvement of a bargain purchase option. Further, the present value of
the lease rentals shall be equal to the price of the laser the machine. The same should be
classified as the capital lease.
Generally Accepted Principle of Accounting:
As per the Generally Accepted Principle of Accounting as well, the above conditions
qualify for capital lease ("Operating versus Capital Leases", 2019).

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References
Operating versus Capital Leases. (2019). Retrieved from
http://pages.stern.nyu.edu/~adamodar/New_Home_Page/AccPrimer/lease.htm
Vaidya, D. (2019). Capital Lease vs Operating Lease | Top Differences You Must Know!.
Retrieved from https://www.wallstreetmojo.com/capital-lease-vs-operating-lease/