Question

Explain why operating and capital leases are accounted for differently?

Answer 1

The major difference between a capital lease and an operating lease is, in capital lease ownership may be transferred to the lessee but in operating lease the ownership is not transferred, it remains with the lessor.

Another difference is in capital lease lessee being the future owner of the property, pays the maintenance, insurance and taxes, but in operating lease the ownership doesn't change so all the maintenance, insurance and taxes are paid by lessor.

Due to these differences they are accounted differently.

In operating lease payment of lease is considered as operating expenses and are shown in profit and loss account. They don't make it to the balance sheet.

But in capital lease, lease are considered as an asset because of transfer of ownership at the end of lease term and the payments are shown in the balance sheet towards the asset.