Difference between Capital Lease and Operating Lease

Lease is agreements in finance where lessor i.e. the owner of assets, buys the asset and allow the lessee i.e. user of assets, to utilize the asset for a restricted timeframe against intermittent installments. The concurrence where terms and conditions in regards to the lease are given is called as Lease Deed. There are two sorts of leases, capital lease and operating lease. Capital lease is form of lease where rewards and risks are conveyed to lessee with the exchange of advantage. On the other hand operating Lease, where only asset is transferred not the rewards and risks to the lessee. In this article we are going to explain the differences between these two forms of lease i.e. capital lease and operating lease.

Capital Lease

Capital lease is an agreement where lessor permits the lessee to utilize a specific asset, for an altered term which covers the significant part of economic life of asset, without exchanging the title yet with the exchange of rewards and risks. It is otherwise called finance lease. In this form of lease the ownership for asset is exchanged to the lessee when the lease term terminates. The tenant has the choice to purchase the asset at nominal price i.e. a value which is not exactly the fair market value. The lease gives back the full payout, i.e. principal cost in addition to interest subsequently of the asset. The capital lease is typically non-cancellable and loan agreement in nature. However, when lessee cancels the agreement losses if any sustain to the lessor will borne by lessee.

Operating Lease

Operating lease is an agreement where the tenant is permitted to utilize a asset with the consent of the lessor, for a restricted term which is by and large littler than the economic life of asset, without the exchange of title, rewards and risks. An operating lease actually a rental agreement in its nature and that is the reason, the rental installments for the utilization of asset are charged a rental cost in the P and L A/C in the books of lessee. Toward the end of the operating lease the asset is neither exchanged to the tenant nor he have the privilege to buy the asset at a cost not exactly the fair market value of asset . The operating lease is cancellable in nature thus it can be cancelled by any party.

Capital Lease VS Operating Lease

  • Definition:

A financial agreement where lessor permits the tenant to utilize the asset for the most extreme part of asset’s economic life against installment of rentals is called as capital lease.

A financial agreement where lessor permits the tenant to utilize the assets for a smaller time period as compare to economic life of assets against the installment of rentals is called as operating lease.

  • Nature:

Capital lease is a loan agreement.

Operating lease is a rental agreement.

  • Time period:

The time period of capital lease is more and longer when compare with operating lease.

The time period of operating lease is less and short.

  • Ownership:

In capital lease, the ownership of asset may be given to lessee, when the time period of lease term comes to an end.

In operating lease, the ownership of assets always retained by lessor, in lease term and after that lessor is the owner of asset.

  • Rewards and risks:

In capital lease, rewards and risks are transferred to lessee from the lessor, in addition to transfer of asset.

In operating lease, rewards and risks are not transferred to lessee from lessor, in addition to transfer of asset.

  • Repairs and maintenance:

In capital lease, all costs, repairs and maintenance are born by lessee.

In operating lease, all costs, repairs and maintenance are born by lessor.

  • Tax:

In capital lease, finance charges and depreciation are allowed as deduction to lessee.

In operating lease, lease rent is allowed as deduction to lessee.

Conclusion

From the above article we come to know that a financial agreement where lessor permits the tenant to utilize the asset for the most extreme part of asset’s economic life against installment of rentals is called as capital lease whereas a financial agreement where lessor permits the tenant to utilize the assets for a smaller time period as compare to economic life of assets against the installment of rentals is called as operating lease. Capital lease is loan agreement and of longer period whereas operating lease is rental agreement and of short period. In capital lease, rewards and risks are transferred but not in operating lease. All costs are born by lessee in capital lease and vice versa. In capital lease, finance charges and depreciation are allowed as deduction to lessee however in operating lease, lease rent is allowed as deduction to lessee.