What is a Lease?
There are many kinds of leases. Some allow the lessee to buy the asset at the end of the lease , some do not, for example. Regardless, a lease is a legal contract, and violating a lease can result in monetary damages or other remedy by a court. Generally speaking, leases set forth the lease dates, the payments required, and guarantees that the lessor actually owns the asset that he or she is leasing to the lessee.
A capital lease is the opposite—it gives the lessee rights similar to those of an owner of the asset. Generally, lease payments made under a capital lease are recorded on the balance sheet and thus do not reduce profits.
GAAP rules state that to determine whether the lease is an operating lease, the lease must not have any of these characteristics:
1. The life of the lease must not be longer than 75% of the life of the asset.
2. The lessor cannot transfer ownership of the asset to the lessee at the end of the lease term.
3. There cannot be an to purchase the asset at a "bargain price" at the end of the lease term.
4. The present value of the lease payments cannot exceed 90% of the fair market value of the asset.
How Does a Lease Work?
Leases can be for a variety of assets, though real estate often comes to mind first. For example, let's say John Doe owns a house on . He does not live in the house; he decides to lease it to Jane Smith. John continues to be the owner of the house, but Jane agrees to pay John $800 a month in return for letting her live there for a . They type up a lease, which sets forth the exact dates Jane can live in the home, what improvements or changes Jane is allowed to make to the home, and what happens if Jane damages the home.
Leases can also be for cars, manufacturing equipment, office space, photocopiers, musical instruments, solar panels, or virtually any other asset. Generally, leases are handy when one party has the capital to purchase the asset and another party does not have the capital to do so but would like access to the asset.
Why Does a Lease Matter?
A lease is an agreement, usually in writing, between the owner of an asset and a lessee.
Personalized Financial Plans for an Uncertain Market
In today’s uncertain market, investors are looking for answers to help them grow and protect their savings. So we partnered with Vanguard Advisers -- one of the most trusted names in finance -- to offer you a financial plan built to withstand a variety of market and economic conditions. A Vanguard advisor will craft your customized plan and then manage your savings, giving you more confidence to help you meet your goals. Click here to get started.
Read This Next
Believe it or not, investing can be a lot like putting your wardrobe together. You can mix and...Read More →
Mexico and Brazil had a big problem several decades ago. They had a small but very wealthy...Read More →
"You can always trust the Americans to do the right thing, but only after exhausting all other possibilities." --Winston Churchill When it comes to our...Read More →
America is over the Nigerian prince scam -- I think -- but there are fresh scams getting invented every day, and not necessarily on the Internet or by email, where you would expect them....Read More →