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What Are the Differences between an Operating and Capital Lease?

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  • Written By: Malcolm Tatum
  • Edited By: Bronwyn Harris
  • Last Modified Date: 11 September 2016
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Both the operating and capital lease strategies are commonly employed in various leasing arrangements. While each option does provide various benefits, there are a few specific differences that exist between operating and capital leases that consumers should keep in mind before settling on one particular approach. Before choosing to lease equipment of any time, investigating these differences and deciding which strategy would provide the greatest benefit is important.

One of the differences between an operating and capital lease is the duration of the lease agreement itself. Typically, a capital lease is intended for use when the intent is to enter into a lease of equipment for a longer period of time, usually defined as over one calendar year. By contrast, an operating lease is normally intended to be a short-term leasing arrangement, making it ideal when the need is to secure equipment for use in a project that will be finished in a few weeks or months.

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Another key difference between an operating and a capital lease is that the capital lease normally focuses on the leasing of newer equipment that is still in active production and is unlikely to become obsolete during the term of the lease. It is not unusual for a capital lease to also include the option for the customer to purchase the equipment at the end of the term if desired. With an operating lease, the equipment is normally something that is subject to obsolescence due to rapid advances in technology, and is likely to be returned to the possession of the owner once the lease ends. For example, heavy machinery such as a vehicle is likely to be the subject of a capital lease, while items like computer equipment would more often be the subject of an operating lease.

There is also some difference between an operating and capital lease when it comes to how the lease is carried in the accounting books of the client. Typically, the expense associated with the capital lease is classed as an asset and is subject to depreciation. The cost of the lease is carried as a debt. By contrast, the operating lease is identified in the accounting records as an operating expense, and the client does not receive any of the benefits normally associated with ownership.

Choosing between an operating and capital lease depends on the particular circumstances of the client. While there are generally accepted applications for each strategy, the situations faced by clients may dictate that pursuing a lease agreement not usually utilized for that particular purpose may be the best option. Before making a final decision, consider all the factors relevant to the situation, then go with the type of lease that will provide the best possible outcome.

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