What is the difference between a capital lease and an operating lease?

The correct choice highlights a fundamental characteristic of capital leases. A capital lease, also known as a finance lease, is structured in such a way that it transfers substantially all the risks and rewards of ownership of the asset to the lessee. This means that the lessee is responsible for things typically associated with ownership, such as maintenance, insurance, and the risk of the asset's residual value at the end of the lease term. Essentially, the lessee treats the lease as if they own the asset for accounting and tax purposes, which is a key feature that distinguishes capital leases from operating leases.

In contrast, operating leases do not transfer ownership risks and benefits to the lessee. The lessee merely rents the asset for a specific period without acquiring the title or significant risks associated with ownership. This difference in how risks and rewards are handled is what fundamentally differentiates these two types of leases, making the selection of the capital lease as the right answer particularly relevant in understanding leasing principles.