What distinguishes a long-term capital lease from other lease types?

A long-term capital lease is characterized primarily by the way payments are structured, particularly in that they are not allocated between principal and interest like traditional financing. In a capital lease, the lessee records the asset on their balance sheet as if they purchased it, given that the lease terms typically allow for the transfer of ownership or significant risks and rewards of ownership are transferred.

This leasing structure is designed to reflect the financial realities of the agreement, where the lessee is using the asset as if they own it. Instead of making a distinction between principal and interest payments, the entire payment under a capital lease contributes to the lease liability and the asset value on the balance sheet.

This differs from operating leases, where the payments are treated as rental expenses, and ownership risks remain with the lessor. Thus, understanding the implications of capital leasing helps organizations in their financial reporting and capital planning, making this distinction particularly important in capital planning practices.