Capital leases and operating leases are two different methods that your company can use to obtain working equipment such as machinery. Both leases are different in terms, accounting and expense reporting.
A capital lease, also known as a finance lease, places all responsibility for the leased equipment on the company leasing the equipment. Typically, the lease cannot be canceled and your company pays expenses and taxes on the equipment until the end of the lease. Sometimes a capital lease may include an option to buy the equipment at the end of the lease.
An operating lease allows you to lease and use equipment while it is necessary and then return it to the lessor, or the entity granting the lease. Upon the return of the equipment, the owner can either re-sell or re-lease it.
You must account for leases in company financial statements, but capital and operating leases are reported differently. A capital lease allows you to depreciate the equipment for tax purposes and list the lease as an asset and a liability. An operating lease is only listed as an operating expense.
Any expenses related to an operating lease, including the payments, are reported as operating expenses. Capital lease expenses are reported as debts, which end up as part of your company’s balance statement.
Leasing, either as a capital or operating lease, allows you to avoid making large down payments for purchases of equipment. Plus, depending on the type of lease, you may be able to lease for a short period of time while building up enough cash flow to make a purchase.