FASB ASC 840 – Leases Operating and Capital – Accounting Standards Codification 840

FASB ASC Guide > FASB ASC 840

Accounting Standards Codification 840, drafted by the Financial Accounting Standards Board, also known as FASB ASC 840, is the section in which relates to leases.  Businesses lease for several reasons, the most commonly known method is where a company (the lessee) more or less rents something from someone else (the lessor).  Based on the idea that you capitalize purchases and expense rent, many companies tried to get around capitalizing fixed asset purchases in order to avoid adding the asset to their balance sheet.  Why?  If you add the asset, you must also add the liability, which can be undesirable based on certain situations.

The type of assets which are expensed are referred to as Operating Leases while the type of lease which must be capitalized is known as a Capital Lease.  The logic behind these two classifications is that some leases are must more like purchases than true leases and therefore should be treated as such.

In order to choose if your lease is Capital or Operating, there is a series of tests in which must be ran.  If the lease does not meet the criteria of any of these tests, it is considered an Operating Lease – if it meets the criteria of even one of the tests then it is classified as Capital.

  • 1. Transfer Test -  Lease transfers ownership at the end of the lease to the lessee
  • 2. Bargain Purchase Test – If at the end of the lease, a bargain purchase option exists for the lessee to buy the asset below market value
  • 3. Economic Life Test – If the lease term is equal to or greater than 75% of the economic life of the asset
  • 4. Fair Market Test – If the present value of the minimum lease payments equal to or greater than 90% of the fair market value of the asset

In summary, leases can be a tricky area of accounting based on these two types of leases and the incentive for firms to classify them either way.  Review the learning outline below for a condensed version of the pronouncement.  Don’t forget to check out our guide to the Accounting Standards Codification now!

  • Allows lessee the ability to use property owned by the lessor for a time period.
  • Capital Lease versus Operating Leases
    • Capital Lease is basically purchasing the asset, therefore must capitalize it on the balance sheet
    • Operating Lease is similar to what most people think of as a lease, and therefore is expensed in the income statement
  • In order to choose if Capital or Operating, there is a series of tests in which must be ran.  If the lease does not meet the criteria of any of these tests, it is considered an Operating Lease – if it meets the criteria of even one of the tests then it is classified as Capital.
    • 1. Transfer Test -  Lease transfers ownership at the end of the lease to the lessee
    • 2. Bargain Purchase Test – If at the end of the lease, a bargain purchase option exists for the lessee to buy the asset below market value
    • 3. Economic Life Test – If the lease term is equal to or greater than 75% of the economic life of the asset
    • 4. Fair Market Test – If the present value of the minimum lease payments equal to or greater than 90% of the fair market value of the asset
  • For Operating Leases, rental expense should as a general rule be recorded on a straight line basis despite the actual cash flows.

Check out more high level explanations of the FASB ASC in our Guide to the Accounting Standards Codification!

For more in depth information on this and other FASB ASC topics, check out the following books.

VN:F [1.9.22_1171]
Rating: 0.0/10 (0 votes cast)

Enter you Email and Win!

Sign up for our drawing for an Apple IPhone to help you organize your business contacts, calendar events, and more, by subscribing to our periodic newsletter. Simply add your email below and you will be enrolled. We will never, ever sell or spam your email, and you can cancel at any time!

Cite this page:

One Response to “FASB ASC 840 – Leases Operating and Capital – Accounting Standards Codification 840”

  1. Jeff Bridges says:

    The Fair Market test in FASB ASC 840 always gets me when its hard to find a comps.

    VA:F [1.9.22_1171]
    Rating: 0.0/5 (0 votes cast)

Contribute meaningful comments to the Accounting community...