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What Is A Capital Lease Versus An Operating Lease?

What is a capital lease versus an operating lease?

An operating lease is what’s traditionally considered a “rental;” the asset stays off the balance sheet and payments are considered operational expenses.  On the other hand, a capital lease is treated more as a loan, and the asset goes on the balance sheet.

For comparison purposes, here are five distinctions between capital leases and operational leases:

Operating lease Capital lease
The lessor retains ownership during and after the lease term The lessee may purchase (own) the asset at the end of the lease term
The lease cannot offer a bargain purchase option at the end of the term The lease does contain a purchase option at less then market value at the end of the lease term
The lease term is less than 75 percent of the estimated economic life of the asset The lease term is equal or greater than 75 percent of the estimated useful life of the asset
The lessee has the right to use only, the risks and benefits are for the lessor The lessee pays maintenance, insurance and taxes on the asset
Lease payments are considered to be rental expenses The lessee is considered the owner, and claims depreciation and interest expenses

Historically, the vast majority of leases have been operational – and remained buried in the footnotes rather than appearing on the company balance sheet. However, with the new lease accounting standards already effective for public companies and the deadline approaching for private company compliance, it is estimated trillions of dollars will be moved to the balance sheet in the form of capital leases.  Choosing a comprehensive, proven lease accounting, lease management and lease administration software from CoStar allows you to manage leases in the manner that best suits company practices and process.

Matt Waters, CPA

Lease Accounting Subject Matter Expert with over 15 years of Management Experience in Accounting and Finance