# USAQuestion about capitalized lease agreement

#### AndrewMew

I have a beginner question on this example related to lease capitalization:

It is a 4-year lease, requiring the lessee to pay \$10,000 per year. The discount rate is 10%.
From these parameters, we can easily get the allocation of the \$10,000 in each year:

 Year Opening Liability Interest Principal Closing Liability Year 0 NA NA NA \$31,700 Year 1 31,700 3,170 6,830 24,870 Year 2 24,870 2,487 7,513 17,357 Year 3 17,357 1,735 8,265 9,092 Year 4 9,092 909 9,092 0

Then the following is the balance sheet of the capitalized lease

 Assets Year 0 Year 1 Year 2 Year 3 Year 4 Leased assets 31,700 31,700 31,700 31,700 31,700 Accumulated depreciation 0 7,925 15,850 23,755 31,700 Net 31,700 23,755 15,850 7,925 0

 Liabilities Year 0 Year 1 Year 2 Year 3 Year 4 Current portion of lease obligation 6,830 7,513 8,265 9,092 0 Long-term debt: lease obligation 24,870 17,357 9,092 0 0 Sum 31,700 24,870 17,357 9,092 0

My questions are:
1. Why do we have to use the straight-line method to depreciate the leased assets? Why can't we just decrease the leased assets by the current portion of lease in each year?
2. Because we depreciate lease assets and lease liabilities in different ways, the lease assets are not equal to the lease liabilities in Year 1, Year 2 and Year 3. How do we re-balance this inequality?

#### AndrewMew

Forgot to mention: accounting under US GAAP

#### BIG E

VIP Member
I suggest you do your homework assignment on your own.

#### AndrewMew

It is not homework. It is an example from the textbook (Page 368 of the Analysis and Use of Financial Statements). I am learning accounting by myself.

#### kirby

VIP Member
Andrew

Book you are using to self-teach yourself was published about 2002. It's too out of date. Suggest "Intermediate Accounting" by Kieso. It is huge and pricey but current.

I get that you are asking a conceptual question only. As to question1, keep in mind that you are dealing with two different things here. The asset is, to put it badly, a physical "thing". Depreciation for assets typically uses st line or an accelerated method. Meanwhile, the lease liability is not a physical thing but a future amount due that is calculated using time value of money.

As for question 2, it is not a problem that both amounts are not equal. And at the end of the lease term, both will have a zero value.