CAPITAL LEASE
Back to GlossaryDefinition
A lease treated as a purchase for accounting purposes (finance lease), recognizing an asset and liability on the balance sheet.
Summary
A capital lease (also called a finance lease) is a long-term rental agreement that is so similar to purchasing an asset that accounting rules require it to be recorded as if the company actually bought the asset. Instead of just recording monthly lease payments as expenses, the company must record both the leased asset (like equipment or property) and the corresponding debt obligation on its balance sheet. This happens when the lease meets specific criteria, such as transferring ownership at the end, having a bargain purchase option, covering most of the asset's useful life, or having payments with a present value close to the asset's fair market value.
Usage Context
Critical for understanding lease accounting, financial statement analysis, debt-to-equity ratios, asset management decisions, and the impact of lease classification on a company's financial position and ratios.
Common Confusions
- Thinking that lease payments disappear entirely (they're split into depreciation and interest expense)
- Confusing capital leases with operating leases and their different accounting treatments
- Not understanding why some leases go on the balance sheet while others historically did not
- Assuming the lease payment amount equals the asset value recorded
- Mixing up the old lease accounting standards with the new ASC 842 rules
