Distinguishing between Capital and Operating Leases

Capital leases and operating leases are two major classifications of leases.

Required:

a. Describe how a lessee accounts for a capital lease both at inception of the lease and during the first year of the lease. Assume the lease transfers ownership of the property to the lessee by the end of the lease.

b. Describe how a lessee accounts for an operating lease both at inception of the lease and during the first year of the lease. Assume the lessee makes equal monthly payments at the beginning of each month during the lease term. Describe any changes in the accounting when rental payments are not made on a straight-line basis.

Note: Do not discuss the criteria for distinguishing between capital and operating leases.

(AICPA Adapted)