A small business accounting for lease

agreements on its financial records

must differentiate between capital and
operating leases. A capital lease must
meet certain criteria for classification,
and payment amounts reduce lease
liability and the period’s income on the
income statement. An operating lease
is recorded as an expense every time
a lease payment is made; at the end of
the fiscal year, a total lease expense
amount reduces the period’s income.
For both operating and capital leases,
each lease payment reduces cash but
their effects on the cash flow
statement vary.