A capital lease is a type of lease agreement in which the lessee (the party leasing the asset) is treated as the owner of the leased asset for accounting purposes. This means that the lessee records the leased asset as an asset on their balance sheet and recognises the lease payments as both an expense and a liability. The lessor (the party leasing out the asset) transfers the risks and rewards of ownership to the lessee, and the lessee is responsible for the maintenance and insurance of the leased asset. A capital lease is typically used when the lessee intends to use the leased asset for a significant portion of its useful life or when the lease agreement includes a bargain purchase option at the end of the lease term.
A capital lease is a lease agreement in which the lessee (the person or company leasing the asset) is essentially treated as the owner of the asset for accounting purposes.
A capital lease is treated as a purchase of the asset being leased, while an operating lease is treated as a rental expense on the lessee’s income statement.
One advantage of a capital lease is that the lessee can claim depreciation expense and interest expense on the leased asset, which can provide tax benefits.
A disadvantage of a capital lease is that the lessee is responsible for the maintenance and repair of the leased asset, as they are treated as the owner for accounting purposes.
The leased asset and the lease liability are both recorded on the lessee’s balance sheet, with the asset being depreciated over its useful life and the lease liability being reduced as lease payments are made.
The criteria for a lease to be classified as a capital lease include the transfer of ownership of the asset to the lessee at the end of the lease term, a bargain purchase option, or the lease term being equal to or greater than 75% of the asset’s useful life.
At the end of a capital lease term, the lessee may have the option to purchase the asset at a bargain price, return the asset to the lessor, or enter into a new lease agreement.
A capital lease can potentially be refinanced, but the terms and conditions of the original lease agreement may impact the ability to refinance.
The legal implications of a capital lease include the responsibilities and obligations of both the lessee and the lessor, as well as any potential disputes or issues that may arise during the lease term. It is important for both parties to carefully review and understand the terms of the lease agreement before entering into it.
This site contains general legal information but does not constitute professional legal advice for your particular situation. Persuing this glossary does not create an attorney-client or legal adviser relationship. If you have specific questions, please consult a qualified attorney licensed in your jurisdiction.
This glossary post was last updated: 4th April 2024.
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