a.

Assets acquired under capital leases are treated very much like other long-term depreciable assets, and capital lease liabilities are treated very much like long-term notes payable.  The only difference is that in a capital lease transaction, the leasee company (i.e., the company having use and enjoyment of the asset during the lease term) does not have actual ownership of the leased asset.  Yet, since the lessee does control the majority of economic benefits to be derived from the use of the asset, it is regarded “in substance” as being the owner of the asset.  Thus, on the lessee’s books, Equipment is debited and a long-term interest-bearing liability called “Capital Lease Liability” is credited for the present value of future lease payments (which is used as a substitute for the asset’s purchase price).  The leased equipment is then depreciated in the same manner as purchased equipment would be depreciated.  Likewise, the initial capital lease liability amount is amortized over the lease term as monthly, quarterly, or annual lease payments are made.  Part of each lease payment is recorded as interest expense, based on the carrying value of the capital lease liability at the beginning of each payment period; the remaining part of each payment is treated as a reduction in the capital lease liability account (i.e., principal amount). 

In effect, capital leases result in the same accounting treatment as do long-term assets (such as equipment) that are purchased using 100% bank financing (i.e., notes payable).  Long-term assets and long-term liabilities are recorded initially for like amounts on the balance sheet.  The long-term asset is depreciated over its useful life while the long-term liability is amortized over the loan term, resulting in depreciation expense and interest expense being recorded in the company’s income statements for several years.