Capital Leases – Buyer Beware!

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Many government contractors enter into equipment leases each year because they don’t have the capital to acquire such assets or have found that leasing equipment is a better option when the equipment is of high use and high turnover.  When contractors enter into such leases, they assume the lease payments are recoverable in their rates throughout the life of the lease, and will start the cycle all over again by entering into a new agreement at the end of the old lease.  This is true for operating leases, but if the lease has similar attributes to ownership, the lease may be a capital lease

If you answer yes to any of the following four questions, you have entered into a capital lease:

  • Is the lease term greater than 75% of the estimated useful life of the asset?
  • Is the present value of future minimum lease payments greater than 90% of the estimated fair market value of the asset?
  • Is there transfer of title of the asset?
  • Is there a bargain purchase option at the end of the lease?

Since capital leases take on similar attributes to ownership, they are accounted for in a similar fashion as a financed fixed asset acquisition, resulting in a portion of lease payments being allocated to an unallowable interest expense account.

The Financial Accounting Standards Board (FASB) is currently undertaking a project to revise this lease standard, which will have an effect on government contractors.

If you have any questions regarding the treatment of capital or operating leases or the direction the standard is going in, please contact your Aronson LLC advisor or a member of Aronson’s Government Contract Services Group at 301.231.6200.

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