Real Estate Services Group
Capital lease analysis
For the purpose of evaluating whether a lease is an operating or capital lease, the University uses the Financial Accounting Standards Statement 13 (FAS 13), and certain subsequent amendments and interpretations. The UC Guidelines on Capital Leases (pdf) as they pertain to real estate (Guidelines) and a Power Point outline of Capital Lease Analysis - The 90% Test (pdf) are presented to support campus efforts to screen leases for possible capital lease treatment.
Capital lease analysis is:
- complex involving four separate, basic determinations based on a complex matrix of rules,
- subject to FAS 13 rules (presently 47 pages) that are periodically amended and interpreted, and
- dependent on subjective judgments despite involving quantitative processes.
Ultimately, the decision to classify a lease as a capital lease, which places it on the University's balance sheet and counts it as debt, is made by the campus Controller and is reviewable by the University's outside auditors. Any significant lease that could be a capital lease should be reviewed very carefully. In assisting the campuses in this review, RESG typically screens the lease with UCOP Financial Management, which may elect to review the lease with the University’s outside auditor to assure that the accounting treatment is fully confirmed before the lease is approved. “Debt by Accident”, i.e. entering into a lease and later determining that it will be booked as a capital lease and therefore as debt, has to be avoided. Note that the Guidelines and other materials in this section are ONLY screening tools and they do not assure that a lease that appears to be an operating lease will ultimately be treated that way. Any lease that is even close to one or more of the four capital lease triggers described in the Guidelines should be reviewed with OP as early as possible.
In addition to the Guidelines and Power Point presentation, a template is provided to calculate whether a lease is a capital lease pursuant to the 90% Test, one of the four capital lease tests. The 90% Test template allows the lease practitioner to plug lease terms and market data into a model to take a first cut at determining whether or not a particular transaction is deemed to be a capital lease under the 90% Test. In the University’s experience, the 90% Test (xls) is most often the reason that real property leases are categorized as capital leases
For a lease of space in a building which space cannot separately acquired (e.g., as a condominium interest), the 90% Test may not need to be performed. If the University is leasing not more than 40% of the building, it is deemed to not make sense to purchase the entire building (even if the 90% test would indicate the lease terms represent a capital lease). For situations in which the University leases more than 40% of the building and the 90% test indicates a capital lease, contact RESG to see if the space in question might qualify for an exception on this basis.
RESG is available to answer any questions you may have regarding the Guidelines or the 90% Test template and to assist you in screening leases for capital lease treatment.