What are the main differences between accounting for operating and capital leases?

A vast majority of leases are operating leases. An operating lease is treated like renting - payments are considered operational expenses and the asset being leased stays off the balance sheet. In contrast, a capital lease is more like a loan; the asset is treated as being owned by the lessee, so it stays on the balance sheet.

As an example, consider a company that signs a 20-year lease to rent a factory. Annual lease payments are $25,000 per year. Accounting for the commitment as an operating lease, the company will simply debit rent expense and credit cash, each year, for $25,000. By contrast, if the company accounts for the commitment as a capital lease, the present value of the lease payment will be reflected on the both the asset side and liability side of the balance sheet, as PPE and long-term debt, respectively. Each year, the company will take depreciation and interest expense charges to income, rather that rent expense.