A longer-term lease transfers the risks and rewards of ownership to the lessee and therefore the accounting treatment is as if the asset had been sold, and the asset is included on the lessee's balance sheet. The lessee depreciates the asset over its life and allocates lease payments to payments of principal and interest.
Generally lessees prefer to structure leases as operating leases since this will give higher operating ratios and lower leverage, whereas lessors prefer to structure leases as capital leases since it allows earlier recognition of revenue and income.
Other factors to consider include:
The following rules decide how leases should be classified.
Under U.S. GAAP, if any of the following conditions hold, a lease is classified as a capital lease.
IAS rules are less stringent and make it easier to classify a lease as an operating lease
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