What is a capital lease characterized by?

A capital lease is characterized by the transfer of significant risks and rewards associated with ownership of the leased asset from the lessor to the lessee. This type of lease is treated similarly to a purchase for accounting purposes, meaning that the asset is recorded on the lessee's balance sheet, along with a corresponding liability for future lease payments.

The key elements that signify a capital lease often include conditions such as the lease term being for a major part of the asset's economic life, the lessee having the option to purchase the asset at a bargain price at the end of the term, or the present value of the lease payments being close to the fair value of the asset. Because of these characteristics, the lessee effectively assumes the economic benefits and risks associated with owning the asset, even though legal title may still rest with the lessor during the lease term.

In contrast, other types of leases, such as operating leases, do not transfer significant risks and rewards, and thus are not accounted for in the same manner.