At inception of a lease for a general capital asset, how should the lease be reflected in the governmental activities accounts?

• A. Debit Expenditure and Credit Cash.
• B. Debit to a Lease Asset and Credit to Lease Obligations Payable.
• C. Debit to a Lease Asset and Debit to Lease Liability.
• D. Credit Lease Asset and Credit Cash.

Answer: (B)

When a government enters into a capital (financing) lease at inception, it recognizes the asset it has acquired and the obligation to make future lease payments. The lease asset is recorded at the lesser of the fair value of the asset or the present value of the minimum lease payments, and the same amount is recorded as a lease liability (lease obligations payable). The corresponding journal entry is a debit to the Lease Asset and a credit to the Lease Obligations Payable. This shows that control of the asset has been obtained and a liability to make future payments exists. Over time, the asset is depreciated and the liability is reduced as payments are made. Recording an expenditure at inception would be appropriate only for an operating lease, not a capital lease, and debiting both the asset and the liability or crediting the asset would misstate the transaction.