 A lease is a contract between a lessor and a lessee that gives the lessee rights to use least property for a specific period of time. Leases continue to grow in popularity as a form of financing because they have many advantages over regular purchases of long-term assets, including often not requiring a large down payment, flexible payment terms and duration, and short durations that protect against obsolescence and additionally they have some tax advantages. For accounting purposes, leases are classified into two categories, operating leases and capital leases. Operating leases are often like rentals. By definition, the lessee does not bear the risk of ownership nor acquire substantially all the benefits of the leased asset. If you or someone you know has ever leased a car, it would be classified as this type of lease because the durations are short. The car has plenty of life and value left once the lease has ended. Let's look at an example and record a journal entry. On July 1, Joy Division leases a recording studio for $10,000 per month for three months. The journal entry includes a debit to rent expense and a credit to cash for the first month's lease payment. Capital leases are very different and it's unlikely any of you have any experience with this type of lease. Capital lease is like a loan to purchase long-term assets, only it's a different type of financing arrangement than a loan. You can see that the risk of ownership and the asset benefit transfer to the lessee, again because the lessee is purchasing the asset via a lease rather than a loan. So let's look at this example and record the journal entry. On July 1, Joy Division leases a touring bus for $1,000 per month for 60 months. The journal entry includes a debit to tour bus and a credit to lease liability for the full value of the asset. Joy Division would then pay down the lease with monthly payments as well as depreciate the tour bus. Finally, I've included the criteria the FAS be used to determine if a lease is a capital lease. One of the four criteria must be met, otherwise a lease would be an operating lease. And note that capital leases are actually recorded at their present value of their lease payments.