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The accounting treatment of leases is an example of the application of the substance over form...

The accounting treatment of leases is an example of the application of the substance over form principle. Discuss how this principle is applied in the accounting for leases.

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Answer #1

A lease is accounted for as either a rental arrangement or a purchae/sale accompanied by debt financing. The choice of accounbting method hinges on the nature of the leasing arrangement.

Capital leases are agreements that we identify as being formulated outwardly as leases, but which are in reality essentially installment purchase. Sometimes the true nature of arrangement is obvious.

Professional judgement is needed to differentiate between leases that represent rental agreements and those that in essance are installment purchase/sales. FASB provides guidance for distinguishing between two fundamental types of leases: capital leases and operating leases.

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