Before making any journal entries, make sure you understand the lease agreement's terms. For example, consider a lease agreement whereby Company A leases a building to Company B for 10 years. Company B will pay a rental payment of $12,000 at the beginning of each year. The building's useful life is 12 years; therefore, this is a capital lease because the lease term is greater than 75 percent of the asset's life.
 Before learning the journal entries it is important to understand the basic accounting process. From an accounting perspective, when you enter into a capital lease, you are basically purchasing the asset, and then financing it using a loan. Therefore the accounting would be very similar to if you simply bought and financed an asset. This means you would first need to add the asset to the balance sheet as a fixed asset, and also add the value of the asset to the balance sheet as a capital lease liability (since you do not own the asset). 

Over the term of the lease, regular payments consisting of interest and principal would be made. The interest portion of the payment would be recorded as an interest expense on the income statement, and the principal would reduce the balance of the capital lease liability.

 For example, assume you were leasing an asset worth $10,000. This means $10,000 would be listed as an asset on the balance sheet, and $10,000 would be listed as a capital lease liability. If you had a $1,000 yearly payment, and $100 was interest, $900 would go towards reducing the capital lease liability account. Over time, this means the capital lease liability account would eventually reach zero..

Finally, you would need account for depreciation. Since assets depreciate over their useful life, you would need to account for the declining value of the asset each year.
 The journal entries will reflect the fact that the lease is essentially a sale. For example, assume Company A leases a building to Company B for 10 years, with an annual rent payment of $12,000.Assume the value of the building is $120,000. Note that the value of the asset is supposed to be equal to the present value of all future rent payments. In this example, we are assuming the value of the building is equal to the sum of all future rent payments ($12,000 times 10 years). In reality, this would be less, since those future rent payments must be discounted to account for the fact that money received in the future is worth less than money received now.

 To begin, open whatever accounting software you are using, debit the "Building" asset account for $120,000, and credit the Lease Payable liability account for $120,000. If these accounts aren't available in your accounting program, you must create them.

This transaction recognizes the building and the lease on the balance sheet.
 Now that the lease is recognized on the balance sheet, you must account for the rental payments. On January 1 each year, you must make a payment to recognize your lease payments to the lessor. 

 To do this, you would debit Lease Payable for $12,000 and credit Cash for $12,000.

 Doing this reduces the value of the Lease payable liability account, to reflect the fact that the principle on the "loan" is being paid down. This transaction also reduces cash as you are paying the lessee.

Note that this assumes there is no interest involved. If part of that $12,000 annual payment is interest, you must debit that portion to the Interest Expense account. 

 For example, suppose that the $12,000 payment included 10 percent interest.  This means that $1,090 of that payment was interest expense.  Therefore, you would record a debit of $10,910 to the capital lease liability account, a debit of $1,090 to the interest expense account and a credit of $12,000 to the accounts payable account.These journal entries will continue to deplete the balance of the Lease Payable account until they reach 0 at the agreement's end.

You may also make monthly payments. Account for it in the same way, but repeat the process twelve times--once for each month. 


, Because a capital lease is treated like a purchase agreement, the lessee will need to record depreciation on the asset in question. In the example above, you would need to depreciate the $120,000 balance in the Building account over its life. The required journal entries would vary depending on the company's depreciation schedule.Depreciation involves taking the value of the asset ($120,000), and reducing its value over the course of its life (10 years). For example, using straight-line depreciation, the asset would depreciate by $12,000 per year ($120,000/10=$12,000{\displaystyle \$120,000/10=\$12,000}).

To account for this, you must charge that amount to the income statement as an expense each year. The basic procedure is to debit the depreciation expense account by $12,000, and then credit the accumulated depreciation account for $12,000.
Evaluate the terms of the lease.
Review the basic accounting process for recognizing a capital lease.
Start by recording the journal entries to recognize the start of the lease.
Record the journal entry to recognize each rental payment.
Record any necessary depreciation expenses.
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