Definition
The term transfer of ownership test refers to one of four capitalization criteria used by lessees to account for a leased property. The transfer of ownership test simply states: If legal title of the leased property is automatically transferred to the lessee as part of the contract, then the agreement should be treated as a capital lease.
Explanation
Companies oftentimes enter into contractual agreements that include the right to use specific property. Since the terms and conditions of these contracts will vary, the Financial Accounting Standards Board issued FAS No. 13 - Accounting for Leases, which outlines the criteria used to determine if the agreement should be treated as a capital versus operating lease.
The transfer of ownership test is considered the least controversial and easiest to implement in practice. If legal title to the leased property passes to the lessee during or at the end of the contract's term, and all of the benefits and risks of ownership transfer, then the agreement should be treated as a capital lease.
There are a total of four capitalization criteria used by lessees to determine if the property should be treated as a capital lease. If the agreement fails any of the four tests, then the arrangement should be treated as a capital lease. The other criteria include: a bargain-purchase option test, an economic life test, and a recovery of investment test.
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