Question: (Comparison of Different Types of Accounting by Lessee and Lessor)

Part 1: Capital leases and operating leases are the two classifications of leases described in FASB pronouncements from the standpoint of the lessee.

Instructions

(b) Describe how an operating lease would be accounted for by the lessee both at the inception of the lease and during the first year of the lease, assuming equal monthly payments are made by the lessee at the beginning of each month of the lease. Describe the change in accounting, if any, when rental payments are not made on a straight-line basis.

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

An operating lease is when a lessor rents an asset to a lessee without transferring ownership of the asset to the lessee. The lessee normally enjoys unfettered use of the item throughout the rental time but is responsible for the asset's condition when it is returned to the lessor at the conclusion of the lease.

At the beginning of the lease, no asset or obligation would be documented. Normally, rent on an operating lease would be charged to expenditure as it became due during the lease term. Rent expense would be recognized on a straight-line basis even if rent payments were not made on a straight-line basis unless another systematic or rational basis is more representative of the time pattern in which use benefit is derived from the leased property, in which case that basis would be used.