Operating leases are a form of rental typically shorter than the expected life of the asset. When operating leases meet certain criteria, they are referred to as off balance sheet financing. Because the business does not own the leased asset, it is not entered on the balance sheet as an asset, nor are the total projected payments listed as a liability. Due to the potential for shareholder misunderstanding of the company's financial position, footnotes are required on the balance sheet disclosing information about operating leases, according to GAAP(Generally Accepted Accounting Principles), and FASB (Financial Accounting Standards Board). The footnote on the balance sheet should include the annual amount of rental payments, general terms of the operating lease, and any other relevant information. Some of the criteria that must be met by a true operating lease include; 25-percent or more of the asset's useful life must remain at the end of the lease, payments cannot exceed 90-percent of the purchase price, and any buyout options at the end of the lease must be at fair market value.
A capital lease is a contract that cannot be canceled where a lessee agrees to make a number of payments for the use of an asset. The lessee assumes the benefits and risks of ownership with a capital lease. This type of lease does meet the criteria of an operating lease; therefore, the asset is recorded on the balance sheet with the other assets owned by the company. The payments for the term of the lease are listed on the right side of the balance sheet with other liabilities. Those payments due within the next 12-months are short-term liabilities, and the balance will be included in intermediate or long-term liabilities depending on the terms of the lease.
The tax lease has the benefits of an operating lease for income tax purposes. According to the parameters established by the Internal Revenue Service Code, a lease is defined by who is retaining the benefits and risks of ownership. This criteria is easier to establish than the criteria required by FASB and GAAP. A true operating lease as described in this article is automatically a tax lease for income tax purposes. The company providing the asset keeps the asset on its balance sheet, and receives any income tax incentives for the investment and ownership of the asset.