Finance Lease vs Operating Lease
A lease is a legal contract that gives the lessee a right to use the asset or product for a specified period of time which is often a large proportion of the useful life of the asset in return for a regular payment to the lessor, who happens to be the owner or manufacturer of the asset. A lease is a generic term that encompasses many types of leases in its fold. But in general, leases can be classified as broadly finance leases and operating leases. These are terms that are more useful for corporate customers, but one should be aware of such differences as leases are becoming increasingly popular these days.
Finance lease and operating lease are the most commonly heard leases in business world. They are similar in may respects though, there is a lot of difference in their structuring. In a finance lease, the lessor, who is the owner or manufacturer of the asset grants the rights of use that include risks and rewards to the lessee, who is the buyer of the asset. Risks include the technology becoming obsolete and those involving wear and tear as well as regular maintenance. In case of a finance lease, the lessee pays an amount that covers almost all the price of the asset and gets to use the asset for most of its useful life. This lease gives an option to the lessee to buy the asset at a greatly reduced price if he so desires after the end of the lease period. A strong feature of a finance lease is that it is not easily cancelled. If the lessee wishes to get the lease cancelled, he has to pay huge penalties.
This is a type of lease where lessor retains rights of ownership and even the risks and rewards lie with the lessor. Lessor pays for the maintenance of the asset during the lease period. Once lease has finished, the asset still has a good value left. This is because the lease period is for a minor part of the useful life of the asset. It differs from finance lease in that it is easily cancellable and is of shorter duration than a finance lease. One common example of an operating lease is installation and use of many computers in an office by a company. Here the user is not responsible for the maintenance of the computers neither is he worried about the systems becoming obsolete as all this is the responsibility of the lessor.
What is the difference between Finance Lease and Operating Lease?
• Major difference between a finance lease and operating lease lies in the ownership of the asset. Whereas risk and rewards are with the lessee in case of finance lease, they lie with the lessor in case of an operating lease.
• Another difference is the manner in which the lease gets reported in financial statements. In case of finance lease, asset is shown on the asset side of the balance sheet, whereas rentals are shown on the side of the liabilities of the balance sheet. On the other hand, an operating lease is shown as operating expense in profit and loss statement.