Definition of Capital Lease
A capital lease is a lease of a non-current asset such as land. The capital lease is a lease agreement that allows the lessee uses the asset over the useful life of the asset against periodic lease payments also called lease instalments. This is also called a finance lease and it normally carries an option that the lessee can purchase the asset at the end of the lease term for a nominal value.
The capital lease is recorded as a liability over the lease term and a corresponding asset is recognized in the balance sheet. The Installments paid in cash contain interest and principal that is deducted from the lease liability amount in the liabilities section as soon as the lease instalment is paid. At the end of the lease term, the leased asset is fully depreciated and all the lease liability is reduced to zero as there are no lease payments left.