Financial Accounting and Reporting-CPA Practice Exam

What is the initial journal entry for capital leases from the lessee’s perspective?

1. Debit cash and credit fixed assets

2. Debit liability and credit cash

3. Debit fixed assets and credit liability

4. Only debit expenses with no credit

The correct answer is: Debit fixed assets and credit liability

The initial journal entry for capital leases from the lessee's perspective involves recognizing both the asset acquired through the lease and the corresponding liability incurred due to the obligation to make lease payments. This entry is recorded as a debit to fixed assets and a credit to liability. The debit to fixed assets acknowledges that the lessee is gaining the right to use an asset, which should be recorded on the balance sheet as an asset. In this case, the capital lease is treated similarly to a purchase of the asset, meaning the lessee effectively owns the asset for accounting purposes. The credit to liability reflects the obligation of the lessee to make future lease payments, thus recognizing the legal responsibility to pay the lessor over the lease term. This dual recognition aligns with the principles of capitalization, which requires that leases meeting certain criteria be accounted for like purchases. Understanding this entry is crucial for lessees as it impacts both the balance sheet and future financial statements, affecting both asset and liability reporting.