Capital Lease vs. Operating Lease: Know the Difference
By Shumaila Saeed || Published on January 20, 2024
A capital lease is a long-term lease recorded as an asset and liability, similar to a purchase. An operating lease is a shorter-term lease not recorded on the balance sheet.
Key Differences
A capital lease, also known as a finance lease, is treated like an asset purchase for accounting purposes, appearing on the balance sheet. Conversely, an operating lease is considered a rental agreement and typically doesn’t appear on the balance sheet. This fundamental classification difference impacts how companies record and report these leases.
Shumaila Saeed
Jan 20, 2024
In a capital lease, the lessee records the leased asset as an asset and the lease obligation as a liability, reflecting ownership-like rights and responsibilities. Operating leases are recorded as an expense on the income statement, affecting operating income but not the balance sheet's assets or liabilities.
Shumaila Saeed
Jan 20, 2024
Capital leases usually have longer terms, often close to the asset's useful life, and include a transfer of ownership option. Operating leases are shorter in duration and involve the lessee returning the asset at the end of the lease term.
Shumaila Saeed
Jan 20, 2024
With a capital lease, the lessee can claim depreciation and interest expenses for tax purposes. In contrast, for an operating lease, the lessee only deducts lease payments as a business expense, not gaining any depreciation benefits.
Shumaila Saeed
Jan 20, 2024
Capital leases transfer most of the risks and rewards of ownership to the lessee, while operating leases keep them with the lessor. This difference affects asset management, maintenance responsibilities, and risk exposure for the lessee.
Shumaila Saeed
Jan 20, 2024
ADVERTISEMENT
Comparison Chart
Balance Sheet Impact
Recorded as an asset and liability
Not recorded as an asset or liability
Shumaila Saeed
Jan 20, 2024
Term Length
Long-term, often near asset’s useful life
Short-term, less than the useful life of asset
Shumaila Saeed
Jan 20, 2024
Ownership
May include a transfer of ownership option
No transfer of ownership; asset returned
Shumaila Saeed
Jan 20, 2024
Financial Statement
Depreciation and interest expenses recorded
Lease payments recorded as an operating expense
Shumaila Saeed
Jan 20, 2024
Risk and Rewards
Lessee assumes most risks and rewards
Lessor retains risks and rewards of ownership
Shumaila Saeed
Jan 20, 2024
ADVERTISEMENT
Capital Lease and Operating Lease Definitions
Capital Lease
May include an option to own the asset eventually.
Our capital lease for the printer includes a buyout option.
Shumaila Saeed
Jan 09, 2024
Operating Lease
Not recorded as an asset or liability.
Our operating lease for laptops doesn’t appear on the balance sheet.
Shumaila Saeed
Jan 09, 2024
Capital Lease
Lessee can claim depreciation on the asset.
We're claiming depreciation on the equipment under our capital lease.
Shumaila Saeed
Jan 09, 2024
Operating Lease
Treated as a rental, not a purchase.
The office space is under an operating lease.
Shumaila Saeed
Jan 09, 2024
Capital Lease
Often spans most of the asset's useful life.
Our capital lease for the vehicle extends for five years.
Shumaila Saeed
Jan 09, 2024
ADVERTISEMENT
Operating Lease
No transfer of ownership risks or benefits.
The risk of the machinery under our operating lease remains with the lessor.
Shumaila Saeed
Jan 09, 2024
Capital Lease
Recorded as both an asset and a liability.
The capital lease increased both our assets and liabilities.
Shumaila Saeed
Jan 09, 2024
Operating Lease
Lease payments deducted as an operating expense.
We deduct monthly payments of our operating lease from our income.
Shumaila Saeed
Jan 09, 2024
Capital Lease
Treated as a purchase of the asset.
The company acquired machinery through a capital lease.
Shumaila Saeed
Jan 09, 2024
Operating Lease
Usually shorter than the asset’s full economic life.
We have an operating lease for the copier for two years.
Shumaila Saeed
Jan 09, 2024
Repeatedly Asked Queries
Can you claim depreciation on a capital lease?
Yes, lessees can claim depreciation.
Shumaila Saeed
Jan 20, 2024
What is a capital lease?
A lease treated as an asset purchase for accounting.
Shumaila Saeed
Jan 20, 2024
What is an operating lease?
A rental agreement not recorded as an asset or liability.
Shumaila Saeed
Jan 20, 2024
How are capital leases shown in financial statements?
As assets and liabilities on the balance sheet.
Shumaila Saeed
Jan 20, 2024
What happens at the end of an operating lease?
The asset is returned to the lessor.
Shumaila Saeed
Jan 20, 2024
Do operating leases affect debt-to-equity ratios?
Not directly, as they don’t appear as liabilities.
Shumaila Saeed
Jan 20, 2024
Can you claim depreciation on an operating lease?
No, only lease payments are deductible.
Shumaila Saeed
Jan 20, 2024
Are operating leases recorded on the balance sheet?
No, they’re recorded as expenses on the income statement.
Shumaila Saeed
Jan 20, 2024
Is maintenance included in operating leases?
Often, the lessor is responsible.
Shumaila Saeed
Jan 20, 2024
What happens at the end of a capital lease?
The lessee may own the asset or extend the lease.
Shumaila Saeed
Jan 20, 2024
Are capital leases common for expensive equipment?
Yes, particularly for long-term use assets.
Shumaila Saeed
Jan 20, 2024
Are operating leases common for office spaces?
Yes, especially for short-term or flexible use.
Shumaila Saeed
Jan 20, 2024
Is maintenance included in capital leases?
Usually, the lessee is responsible for maintenance.
Shumaila Saeed
Jan 20, 2024
How does an operating lease impact company assets?
It has no direct impact on assets.
Shumaila Saeed
Jan 20, 2024
Do capital leases affect debt-to-equity ratios?
Yes, they can increase liabilities.
Shumaila Saeed
Jan 20, 2024
Can capital leases be canceled easily?
No, they typically have stringent terms.
Shumaila Saeed
Jan 20, 2024
Share this page
Link for your blog / website
HTML
Link to share via messenger
About Author
Written by
Shumaila SaeedShumaila Saeed, an expert content creator with 6 years of experience, specializes in distilling complex topics into easily digestible comparisons, shining a light on the nuances that both inform and educate readers with clarity and accuracy.
Shumaila Saeed
Hifza Nasir
