What criteria must be met for a lease to be classified as a capital lease under GAAP?

• A. If it includes a cancellation option
• B. If it meets any of the four criteria: ownership transfer, bargain purchase option, lease term is 75% of asset life, or present value of payments is 90% of asset fair value
• C. If it exceeds one year in duration
• D. If it requires annual payments

Answer: (B)

A lease is classified as a capital lease under GAAP if it meets any of the four specific criteria outlined in the accounting standards. This classification is significant because it signifies that the lease conveys substantially all the risks and rewards of ownership of the asset to the lessee, thereby requiring the asset and liability to be recognized on the balance sheet.

The four criteria for classification as a capital lease are:

1. Ownership Transfer: If the lease agreement provides for the transfer of ownership of the asset to the lessee by the end of the lease term.

2. Bargain Purchase Option: If the lease includes a purchase option that allows the lessee to buy the asset at a price lower than its expected fair value at the date the option becomes exercisable.

3. Lease Term: If the lease term is for 75% or more of the estimated economic life of the asset.

4. Present Value of Payments: If the present value of the minimum lease payments equals or exceeds 90% of the fair value of the asset at the inception of the lease.

Meeting any one of these criteria would justify the capitalization of the lease, thus reflecting the lessee's long-term commitment and the associated asset and liability on the financial statements. This classification contrasts with an