OPERATING LEASE VS FINANCIAL LEASE
In Accounting, term Operating leases and a financial lease is very common and well used. Operating leases are cast-off for short-term leasing of assets. It is similar to hiring the asset. This process does not involve the transfer of ownership, whereas the financial lease is the long-term leasing of an asset. This process consists of the transfer of ownership right to the lessee after a particular time and periodic payment. That seems like selling the assets on installments.
Definition of Operating Leases:
Operating lease defined as “a contract where the owner authorized the lessee to use an asset for a selected period. This agreement represents the smaller economic life of the asset without transferring ownership rights.”
The Lessor gives the right to the Lessee in return for regular payments for a contracted period. That specifies that operating lease is the renting of an asset from the owner, but not under terms to transfer ownership rights of the asset to the rental party. During the defined period, the rental person has typically full rights to use the asset and also responsible for the condition of the asset at the end of the agreement when it returned to the lessor. When a business replaces its assets regularly, and need to switch out old assets to new ones, an operating lease is beneficial in those situations.
Definition of Financial Leases:
Financial lease defined as “a contract where the owner, authorized the lessee to use an asset and periodic payment for the selected period, the rights of ownership is also transferred to lessee” This is also known as a capital lease.
For the financial lease, the following conditions should be satisfied:
- The lessee can purchase the asset after the contract is expired.
- The lessee can get ownership rights of the asset after the lease is expired.
- The lease payment value is at least 90% of the asset value.
Difference between Operating and Financial lease:
| Aspects | Operating Lease | Financial Lease |
| Ownership
Rights |
The lessor has ownership rights of an asset for the whole lease period | The ownership rights may transfer at the end of the lease period is given to the lessee. |
| LEASE TERM and conditions | The lease term may extend to less than 75% of the projected life of an asset | The lease term is the considerable economic life of the leased asset |
| PURCHASING OPTION | the lessee does not have a right to buy the asset during the lease period | the lessee has a purchase option at less than the market value of the asset |
| EXPENSES TOLERATED | The lessee pays the monthly lease payment | The lessee bears all the costs of insurance, maintenance, and taxes. |
| TAX BENEFITs | Operating lease is as good as renting, and the lease payment is considered an expense with no claim of depreciation. | The lessee can entitle both interest and depreciation, as the lease treated as a loan. |
| EFFECT ON ACCOUNTING | This lease is like renting, expenses of the business. That means the lease payments processed as operating expenses, and the asset does not show on the balance sheet. | A financial lease processed as a loan. the lessee considers asset ownership, so the asset appears on the balance sheet |
Conclusion-add financial lease
As corporations typically use operating and financial leases, it is useful to gain an understanding of the accounting and proportionate tax treatment for leases for both the lessor and the lessee. Both contracts come with many advantages. It depends on the company’s requirements and the tax situation.
