The criteria for classifying a lease as operating or capital:
Leases that do not transfer substantially all the benefits and risks of ownership are operating leases. The criteria for capitalization of leases are as follows: first, it is considered inappropriate to capitalize any leased assets; second, leases should be capitalized that are similar to installment purchases; third, all long-term leases should be capitalized; and finally, it is appropriate to capitalize firm leases where the penalty for nonperformance is substantial.

Why is there a difference between operating and capital leases?
If leasing a piece of property the lease costs are recognized currently in the income statement. If a substantial majority of the life of the property is in the lease agreement then it is essentially a purchase or an installment sale, the reality is it is purchasing an asset, whether it is a piece of personal property or real property.

What are the implications of an operating lease versus a capital lease on an entity’s financial statements?
Implications associated with operating leases versus capital leases on the entity’s financial statement are as follows: an operating lease recognizes the cost of the lease with each payment made, whereas a capitalized lease provides for several different methods of allocating the cost of a lease over its useful life. For instance, a capitalized leased is basically a purchased asset that could be depreciated on the straight-line method or the declining-balance method.

The different methods used to calculated depreciation:
There are several different methods used to calculate depreciation. The activity method, also referred to as the units-of-production method, depreciates assets as a function of productivity, instead of the passage of time. The straight-line method, unlike the activity method, depreciates assets as a function of time; calculated by dividing the cost of the asset (less salvage value) by the estimated service life. There is also the decreasing charge methods – sum-of-the-years’ digits and declining-balance method; and special depreciation methods – group and composite methods and hybrid (or combination) methods.

How does a company decide which method they should utilize?
Depending on the type of product and/or the type of asset used to produce the product will likely help a company decide on their depreciation method. For example, a company that produces widgets would likely utilize the activity method; however, on the other hand a company that uses low maintenance and long-life assets, such as a building, requiring regular repair and maintenance would most likely use the straight-line approach.

How does a company’s choice affect their financial statements?
A company’s office equipment, computers, electronic devices would affect the financial statements by their depreciating the cost of the equipment over the first few years of their lives. This would affect the income statement more-so over the first few years of its life and less over the later years. Straight-line and units of production generally depreciate more evenly over their life.

Should there be a standardized method of depreciation for enhancing comparability?
It isn’t a good idea to standardize the method of depreciation, because every asset is different and it depreciates differently; so it would make more sense to depreciate the asset over its useful life.