Operating Leases vs. Capital Leases

The two major types of leases you will come across are operating leases and capital leases.  Each type of lease will be dealt with differently for accounting purposes.

An operating lease is a contract that allows you to use an asset but does not convey ownership rights to that asset.  This is a type of off-balance sheet financing, and is typically short-term in nature, and are only acquired for a fraction of the equipment’s useful life.

A capital lease is a contract entitling you to the temporary use of an asset, which does convey ownership rights.  Capital leases require you to book assets and liabilities associated with the lease if the contract meets these specific requirements:

1) There is an ownership transfer to the lessee at the end of the lease,

2) The lease contains a bargain purchase option,

3) The lease life exceeds 75% of the asset’s economic life, and

4) The present value of the lease payments exceed 90% of the asset’s fair market value.

Operating leases are recorded as expenses.  You don’t have to follow any special rules.  On your tax return, the total amount will be combined with other rent payments made throughout the year.

Capital leases are treated in the same manner as loans, except that we keep them in a separate section for organization purposes.

When you make a capital lease payment, you may need to pay interest on top of the principle and GST.  Split up the expenses, if possible.

Last updated on November 4, 2019 by FCC AgExpert