What characterizes a capital lease?

A capital lease, now referred to as a finance lease under accounting standards, is characterized by the transfer of risks and rewards of ownership from the lessor to the lessee. This transfer implies that the lessee bears the economic benefits and risks associated with the asset, similar to an ownership situation. While the legal title may not transfer, the lessee effectively controls the asset for most of its useful life and is often responsible for its maintenance and insurance.

In a capital lease scenario, the lessee recognizes the leased asset on their balance sheet, along with a corresponding liability. This reflects the nature of the agreement where the lessee is treated like an owner for accounting purposes. The criteria for determining if an arrangement is a capital lease typically involve factors such as the length of the lease relative to the asset’s useful life, lease payments relative to fair value, and whether ownership is transferred at the end of the term.

In contrast, short-term leases are typically operational leases and do not provide the same level of ownership benefits and risks. Maintenance costs generally encompass more than just the lessee covering basic maintenance, and the characteristic of a capital lease is that it is, in fact, recorded on the lessee's balance sheet rather than omitted. All of these