(a) if legal title passes to the lessee;
(b) if the lease contains a bargain purchase option;
(c) if the lease term (the length of the lease) equals or exceeds 75 percent of the asset's life; and
(d) if the present value of the minimum lease payments equals or exceeds 90 percent of the fair value of the leased property. If none of the four criteria is met, then the business enterprise treats the lease as an operating lease.

Accounting for these leases differs amazingly. In a capital lease, the firm capitalizes the asset at its present value (not to exceed its fair value), and it capitalizes the lease obligation at the present value of future cash flows. On the income statement, the business enterprise shows the depreciation of the capitalized asset and displays the interest expense on the lease obligation. In an operating lease, the entity ignores its property rights and it pretends that it has no debts. On the income statement, the organization acknowledges a rent expense. There is, however, no economic justification for this differential treatment.

If these rumblings represent an actual concern about the pathetic state of lease reporting in this country, I have two suggestions for FASB.

First, I think it useful for the board to follow its own conceptual framework. Recall that this conceptual framework defines assets as "probable future economic benefits obtained or controlled by a particular entity as a result of past transactions or events." Further, this conceptual framework defines liabilities as "probable future sacrifices of economic benefits arising from present obligations of a particular entity to transfer assets or provide services to other entities in the future as a result of past transactions or events." It doesn't take a school janitor, much less a rocket scientist, to figure out that leases confer on lessees probable future economic benefits and probable future sacrifices. Operating leases contradict this rational approach of reporting the economics of these business transactions. If the board only applies its own conceptual framework, then it will achieve a much better accounting.

My second suggestion to board members calls for them to get serious with their call for simplicity and for principles-based accounting. The FASB should forget all of the minutia dealing with implicit interest rates versus incremental borrowing rates, residual values, contingencies, and all of the other garbage discussed in Statement No. 13 and its myriad amendments and interpretations. Let the principle be simple: measure the capitalized asset at its fair value and measure the lease obligation at its present value. There is no need for the other trivia; let the plaintiffs attorneys keep a watchful eye on managers and auditors for proper application.

Such an approach is simple, principles-based, rational, and generates relevant financial information. In fact, this is such an obvious improvement to the pitiful existing standards that FASB should forget its due process and just issue the new statement today.

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J. EDWARD KETZ is accounting professor at The Pennsylvania State University. Dr. Ketz's teaching and research interests focus on financial accounting, accounting information systems, and accounting ethics. He is the author of Hidden Financial Risk, which explores the causes of recent accounting scandals. He also has edited Accounting Ethics, a four-volume set that explores ethical thought in accounting since the Great Depression and across several countries.