• 3,000 firms
  • Independent
  • Trusted
Save up to 70% on staff

Home » Articles » Capital lease vs. Operating lease: Side-by-side comparison

Capital lease vs. Operating lease: Side-by-side comparison

Leasing has become a popular option for businesses to acquire assets without the full upfront cost, providing flexibility and financial advantages.

Two primary options stand out: capital lease and operating lease. The right type of leasing holds substantial importance for businesses due to its far-reaching financial implications. 

The decision shapes how a business utilizes assets, directly impacting its cash flow, tax deductions, and overall flexibility.

This article explores Capital lease vs. Operating lease, including their distinct features, benefits, and drawbacks.

Defining capital lease

A capital lease is a leasing arrangement where the lessee undertakes a significant portion of the risks and rewards associated with owning the leased asset. The lessee can either be an individual or a business entity.

Get 3 free quotes 2,300+ BPO SUPPLIERS

This type of lease is similar to purchase in accounting and financial reporting, as it effectively transfers the benefits and responsibilities of ownership to the lessee.

As a result, the leased asset is treated as if it were owned by the lessee for accounting and financial reporting purposes.

Defining capital lease
Defining capital lease

Characteristics of capital lease

A capital lease is more than just a simple rental agreement; it embodies a series of features that align it closely with asset ownership. 

Here are the following characteristics of a capital lease:

Ownership transfer at the end of the lease term

This characteristic underscores the long-term commitment and investment-like nature of capital leases.

The lease agreement typically outlines the conditions under which ownership is transferred. It marks a strategic departure from other leasing arrangements where ownership remains vested with the lessor.

The transfer of ownership isn’t just a formality; it signifies a fundamental shift in the lessee’s relationship with the asset.

Get the complete toolkit, free

As a result of this transfer, the lessees are entitled to recognize the asset as their own on the balance sheet. This leads to potential enhancements in financial ratios and the lending capacity of the business.

Bargain purchase option

Embedded within many capital leases is a financial provision known as the bargain purchase option.

This facet extends the lessee a unique advantage: The opportunity to acquire the leased asset at a notably reduced price compared to its prevailing fair market value at the end of the lease term.

This option substantially strengthens the lessee’s standing as a potential future owner. The lease arrangement becomes increasingly appealing economically by offering the chance to purchase the asset at a bargain.

Longer lease term

Capital leases are characterized by their extended lease terms. This strategic decision to engage in a lengthier commitment often aligns with the nature of the leased asset’s useful life. 

The concept of a longer lease term supports businesses aiming to secure the advantages of a capital lease over an extended duration. It particularly suits industries where the asset’s lifecycle exceeds the standard periods covered by operating leases. 

Pros and cons of capital lease

Here are the pros and cons of the capital lease:

Gain ownership of the asset at the end of leaseAdds to long-term liabilities
Enhances financial ratiosRequires detailed financial reporting
Claim depreciation deductionsGenerally more expensive than operating leases upfront
Customize and use the asset as neededLessee is responsible for maintenance costs
Benefit from any appreciation of the assetThe asset might become outdated

Defining operating lease

In an operating lease, the lessee gains access to an asset for a predetermined period, usually shorter than the asset’s anticipated useful life. This type of lease allows businesses to utilize assets for specific projects or needs without committing to long-term ownership.

In other words, an operating lease does not involve such ownership transfer. Instead, the lessor retains ownership and often provides options for the lessee to return, renew or upgrade the lease.

Defining operating lease
Defining operating lease

Characteristics of operating lease

Operating leases provide businesses flexibility and short-term asset access without entailing ownership responsibilities. 

Here are the following characteristics of an operating lease:

No ownership transfer at lease end

Unlike capital leases, where the lessee gains ownership of the asset at the end of the lease term, operating leases maintain a distinct separation between lessee and ownership. 

Instead of assuming ownership, the lessee is typically presented with multiple options as the lease term concludes.

No bargain purchase option

Operating leases are also distinct in their lack of a bargain purchase option, a feature commonly found in capital leases.

This feature suits the shorter-term nature of operating leases, where the primary objective is to utilize the asset for a specific duration rather than commit to long-term ownership. 

Shorter lease term

Operating lease allows businesses to acquire assets for specific projects, short-term needs, or situations where asset turnover is frequent. This feature appeals to businesses engaged in seasonal operations or those with dynamic operational demands. 

Pros and cons of operating lease

Here are the pros and cons of an operating lease: 

Can be easily upgraded to new assetsNo asset ownership
Lower initial financial commitmentCumulative costs might exceed purchasing
Lessors are often responsible for maintenanceNo gains from asset value increase
Deduct lease payments as operating expensesLimited customization options
Lesser risk of asset obsolescenceCannot claim depreciation deductions

Capital lease vs. Operating lease: Comparing differences

By examining the distinctive aspects between capital and operating leases, we can unravel how each lease type influences a company’s financial health.

Capital lease vs. Operating lease: Key differences
General financial implications comparisonCapital leaseOperating lease
Accounting treatment and reportingRegistered as an asset and liability on the balance sheetOnly lease payments are recorded as expenses
Impact on the balance sheet and liabilityBoosts both assets and liabilities on the balance sheetHas a smaller impact on the balance sheet
Maintenance and risk responsibilityLessee is responsible for maintenance and riskLessor often retains maintenance responsibility
Tax implicationsHave depreciation benefits and interest expense tax deductionsLease payments are tax-deductible operating expenses but don’t have depreciation benefits

Capital lease vs. Operating lease: When to choose the right lease

Capital lease vs. Operating lease, what’s in it for you? 

The choice between these two leases depends on various factors, such as the business’s financial goals, long-term plans, and the nature of the asset. 

Opt for a capital lease when you:

  • Intend to use the asset for its entire useful life
  • Want ownership benefits
  • Are prepared to manage the asset’s maintenance and related costs

Choose an operating lease when you need the flexibility to upgrade assets frequently but prefer to avoid ownership and long-term maintenance responsibilities.

Understanding each option’s key differences can help you make an informed choice that aligns with your organization’s objectives and resources.

Get Inside Outsourcing

An insider's view on why remote and offshore staffing is radically changing the future of work.

Order now

Start your
journey today

  • Independent
  • Secure
  • Transparent

About OA

Outsource Accelerator is the trusted source of independent information, advisory and expert implementation of Business Process Outsourcing (BPO).

The #1 outsourcing authority

Outsource Accelerator offers the world’s leading aggregator marketplace for outsourcing. It specifically provides the conduit between world-leading outsourcing suppliers and the businesses – clients – across the globe.

The Outsource Accelerator website has over 5,000 articles, 450+ podcast episodes, and a comprehensive directory with 3,900+ BPO companies… all designed to make it easier for clients to learn about – and engage with – outsourcing.

About Derek Gallimore

Derek Gallimore has been in business for 20 years, outsourcing for over eight years, and has been living in Manila (the heart of global outsourcing) since 2014. Derek is the founder and CEO of Outsource Accelerator, and is regarded as a leading expert on all things outsourcing.

“Excellent service for outsourcing advice and expertise for my business.”

Learn more
Banner Image
Get 3 Free Quotes Verified Outsourcing Suppliers
3,000 firms.Just 2 minutes to complete.
Learn more

Connect with over 3,000 outsourcing services providers.

Banner Image

Transform your business with skilled offshore talent.

  • 3,000 firms
  • Simple
  • Transparent
Banner Image