In simple words, a lease can be defined as an agreement that states the right to use a plant, property, or machinery for a given period. The party which secures the right to use an asset is a lessee whereas, the one who owns it is known as the lessor.
It must be noted that there are several types of leases available in the market today, including capital lease and operating lease. While both are quite popular among business owners, one must make it a point to find out the features and benefits of each of these leases. For instance, at KredX, businesses can use their rental agreements and leases to gain access to growth capital and boost their operations.
Being familiar with the pros and cons of each such lease, helps to determine which of them is more suitable for a business at a given point of time. To gain a fair idea about it, companies should look at these pointers that elucidate operating lease vs capital lease, to make a more informed decision.
Typically, an operating lease can be defined as a contract that permits an asset to be used under pre-defined terms. However, such an agreement does not give the business entity any ownership right.
An operating lease is a type of off-balance-sheet financing. It means that a leased asset’s accompanying liabilities, like rent pay-outs, are not included on the firm’s balance sheet.
Any lease that does not meet any of these 4 criteria, is treated as an operating lease –
This is a rental agreement that allows a renter to use an asset owned by another individual, for a specific period and as per pre-determined terms. Notably, such a lease manifests characteristics of ownership of assets, especially for requirements related to accounts.
A capital lease is also known as a financial lease. This lease requires the lessee to record underlying assets as their own.
Typically, to qualify as this rental lease, a contract must meet any of these criteria –
All fundamental differences between an operating lease and capital lease, root from their disparity in accounting and structure.
On that note, glance through this table below which highlights some noteworthy differences between operating lease and capital lease. Doing so will help in gaining a detailed insight into the difference between operating lease and capital lease –
Parameter |
Operating Lease |
Capital Lease |
Purpose |
Operating lease is an alternative to renting PP&E against a fixed rental pay-out. |
A capital lease is an alternative means of purchasing PP&E on debt financing. |
Ownership |
Lessor retains ownership of assets in question even after the end of the lease term. |
The ownership of leased assets may be transferred to the lessee when the term ends. |
Term of lease |
Its term is usually less than 75% of the economic life of the machinery. Typically, it is active for the short term. |
The term usually equals or is more than 75% of the asset’s shelf life. It is active for the long term. |
Accounting treatment |
In accounts, payments are considered as operating expenses. As a result, it is shown in the Profit and Loss Statement. |
Leased assets are recorded as assets, while the lease payments are recorded as a liability. Also, the payments are recorded in the balance sheet. |
Depreciation |
An operating lease does not depreciate. |
A capital lease depreciates with time. |
Tax benefit |
Lease pay-outs are treated as a rental expense. |
A lessee can claim depreciation expense along with interest expense as they are considered to be the equipment’s owner. |
Bargain purchase option |
The bargain purchase price is not available. |
The bargain purchase option is available. |
Transferability |
The associated risk and reward tend to remain with lessors. |
The risk and reward get transferred to lessees. |
Risk burden |
The risks and benefits remain with lessors. Also, lessees have to pay the maintenance cost. |
Lessee has to pay the maintenance, tax, and insurance charge. |
KredX’s lease rental discounting facility enables companies to get the capital tied up in rental agreements or leases, thereby providing upfront funds for growth and expansion.
Notably, businesses must also give due attention to the accompanying terms of service and liabilities, when it comes to operating lease vs capital lease. Doing so will help them to gain a better idea about all intricacies related to both the options.