Capital Lease or Operating Lease?
Businesses often choose to lease long-term assets rather than buy them for a variety of reasons
- the tax benefits are greater to the lessor (think seller) than the lessees (the person making payments)
- leases offer more flexibility in terms of adjusting to changes in technology and capacity needs.
Lease payments create the same kind of obligation that traditional loan payments create, and have to be viewed in a similar light. If a business is allowed to lease a significant portion of its assets and keep it off its financial statements, in particular, the Balance Sheet, the reader of the statements will be given a very misleading view of the company's financial strength, by not showing all the debt. Consequently, accounting rules have been devised to force businesses to reveal the extent of their lease obligations on their books.
There are two ways of accounting for leases.