Question: For a lessee, a radical reporting difference exists between operating leases and capital leases.
Company officials prefer operating leases so that the amount of reported liabilities is lower. What is the
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distinction between an operating lease and a capital lease?
Answer: In form, all lease agreements are rental arrangements. One party (the lessor) owns legal title to property
while the other (the lessee) rents the use of that property for a specified period of time. However, in substance, a
lease agreement may go beyond a pure rental agreement. Financial accounting has long held that a fairly presented
portrait of an entity’s financial operations and economic health can only be achieved by looking past the form of a
transaction in order to report the actual substance of what is taking place. “Substance over form” is a mantra often
heard in financial accounting.