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
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.