Capital Lease vs. Operating Lease: What's the Difference?
Edited by Aimie Carlson || By Harlon Moss || Published on January 17, 2024
A capital lease is a long-term lease treated as an asset purchase, while an operating lease is a shorter-term lease recorded as an expense.
Key Differences
A capital lease is akin to purchasing an asset with a long-term commitment, whereas an operating lease is more like renting an asset for a short term.
In a capital lease, the asset is recorded on the lessee's balance sheet, reflecting ownership. An operating lease, however, is treated as an operating expense and does not appear as an asset.
Capital leases transfer the risks and rewards of ownership to the lessee. Operating leases do not transfer these risks and rewards, keeping them with the lessor.
At the end of a capital lease, the lessee often has the option to purchase the asset. Operating leases typically end with the return of the asset to the lessor.
Capital leases can offer depreciation benefits and interest expense deductions. Operating leases, being off-balance sheet, offer different tax advantages.
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Comparison Chart
Duration
Long-term commitment.
Short-term agreement.
Financial Treatment
Recorded as an asset and liability.
Treated as an expense, not as an asset.
Risk and Rewards
Transfers ownership risks to the lessee.
Risks remain with the lessor.
End of Lease
Option to purchase the asset.
Asset returned to the lessor.
Accounting Impact
Asset depreciation and interest deductions.
Off-balance sheet, different tax benefits.
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Capital Lease and Operating Lease Definitions
Capital Lease
The lessee can claim depreciation on a capital lease.
They benefited from depreciation deductions on their capital lease.
Operating Lease
Operating leases are recorded as an expense in financial statements.
Monthly payments under the operating lease were expensed in their income statement.
Capital Lease
A capital lease is a lease agreement where the lessee assumes some risks of ownership.
The company acquired machinery through a capital lease.
Operating Lease
Operating leases do not transfer ownership risks to the lessee.
Equipment maintenance remained the lessor's responsibility under the operating lease.
Capital Lease
Capital leases typically include a buyout option at the end.
At the lease's end, they plan to buy the equipment.
Operating Lease
Operating leases keep the asset off the lessee’s balance sheet.
The asset under the operating lease did not appear on their balance sheet.
Capital Lease
Capital leases are treated as an asset purchase in accounting.
The capital lease was recorded on the balance sheet as an asset.
Operating Lease
Operating leases offer flexibility and shorter commitment.
They chose an operating lease for its short-term flexibility.
Capital Lease
Capital leases often span a significant portion of the asset's life.
Their capital lease agreement lasts almost as long as the equipment's expected lifespan.
Operating Lease
An operating lease is a rental agreement for a short period.
The company entered an operating lease for office printers.
FAQs
What is a capital lease?
A lease treated as an asset purchase for accounting purposes.
Can you buy the asset at the end of a capital lease?
Often, there is a buyout option at a reduced price.
What is an operating lease?
A short-term lease agreement, treated as a rental.
How is an operating lease recorded?
As an operating expense on the income statement.
What happens at the end of an operating lease?
The asset is returned to the lessor.
Are operating leases shown on the balance sheet?
No, they are off-balance sheet items.
How is a capital lease recorded in accounting?
As an asset and a corresponding liability.
Who maintains the asset in an operating lease?
The lessor typically maintains the asset.
Is an operating lease suitable for short-term needs?
Yes, it's ideal for short-term or flexible needs.
What kind of assets are typically under capital leases?
Long-term, high-value assets like machinery or vehicles.
Do capital leases offer depreciation benefits?
Yes, lessees can claim depreciation.
Are operating leases commonly used for office equipment?
Yes, like printers and computers.
How does an operating lease affect cash flow?
It's a regular expense, impacting operational cash flow.
Can a capital lease improve asset turnover ratio?
It can, as the asset is owned and utilized by the lessee.
What is the impact of a capital lease on profitability?
It can affect profitability due to interest and depreciation expenses.
Which lease transfers ownership risk?
A capital lease transfers ownership risks to the lessee.
How does a capital lease affect a company's debt ratio?
It increases the debt ratio due to the liability on the balance sheet.
Do operating leases require a down payment?
Usually, they do not require significant upfront payments.
Is an operating lease cancellable?
Yes, typically with more flexibility than a capital lease.
Can you terminate a capital lease early?
It's possible but may involve penalties or costs.
About Author
Written by
Harlon MossHarlon is a seasoned quality moderator and accomplished content writer for Difference Wiki. An alumnus of the prestigious University of California, he earned his degree in Computer Science. Leveraging his academic background, Harlon brings a meticulous and informed perspective to his work, ensuring content accuracy and excellence.
Edited by
Aimie CarlsonAimie Carlson, holding a master's degree in English literature, is a fervent English language enthusiast. She lends her writing talents to Difference Wiki, a prominent website that specializes in comparisons, offering readers insightful analyses that both captivate and inform.
