Capital Leases and Operating Leases
A lease can be an operating lease or a capital lease.
Operating Lease – Typically a short-term lease where the lessor retains most of the benefits and risks associated with owning the asset. In operating lease, no asset and liability are recorded on the lessee’s balance sheet. Lease payments are reported as expense when paid.
Capital Lease – Typically a long-term lease where the lessee assumes most of the benefits and risks associated with owning the asset. In capitalizing a lease, an equal balance sheet asset and liability are created and both are reduced over the term of the lease; these reductions are expensed to the income statement. Note that ‘Capital lease’ is the term used by US GAAP. Under IFRS it is called ‘Finance lease’.
Lessees and Operating Leases – A company may be incented to treat leases as operating leases because the financial commitment associated with the operating lease contract is not recorded on the balance sheet as a liability. Operating leases can be seen as a form of off-balance sheet financing for a company. If a lease is capitalized by a lessee, the resulting liability will have debt-like impacts on a company’s financial ratios.
Lessors and Capital Leases – Companies who act as lessors may be incented to treat leases as sales-type capital leases in order to show higher net income.
Get smart about tech at work.
As a non-technical professional, learn how software works with simple explanations of tech concepts. Learn more...
- Recognition and Measurement of Bonds
- Bond Amortization, Interest Expense, and Interest Payments
- Derecognition of Debt
- Role of Debt Covenants
- Presentation and Disclosures Related to Debt
- Leasing Vs. Purchasing Assets
- Capital Leases and Operating Leases
- Lessee Accounting
- Effects of Leases on Selected Financial Reporting Items for Lessees
- Lessor Accounting for Leases
- Lessors and Sales-Type Capital Leases
- Lessors and Direct Financing Capital Leases
- Effect of Leases on Financial Statements for Lessors
- Disclosures for Capital and Operating Lease
- Defined Benefits Plans vs. Defined Contribution Plans
- Pension Expense (both GAAP & IFRS) for the Income Statement
- Defined Benefit Plans & the Company Balance Sheet