Difference between Operating and Financial Lease

Difference between two basic forms of lease viz. operating lease and finance (capital) lease are mainly on the basis of who owns the leased asset, what accounting and tax treatment are given, who bears the expenses and running costs, whether purchase option is there or not and what is the lease term.

Difference Between Financial (Capital) Vs. Operating Lease:

The differences are explained with help of the following table against various aspects of each of the operating and financial lease.

Aspects of Difference Operating Lease Financial (Capital) Lease 

Definition

A lease in which all risks and rewards related to asset ownership remain with the lessor for the leased asset is called operating lease. In this lease, the asset is returned by the lessee after using it for lease term agreed upon. Read Operating Lease for an in-depth coverage. In financial lease (Also known as a capital lease), the risks and rewards related to ownership of asset leased are transferred to the lessee. Read Finance Lease for an in-depth coverage

Ownership

The ownership of the asset remains with the lessor for the entire lease period. Ownership transfer option at the end of the lease period is there with the lessee. The title might or might not be transferred eventually.

Accounting Effect

Operating lease is treated generally like renting. That means, the lease payments are treated as operating expenses and the asset does not show on the balance sheet. A financial lease is treated like loan generally. Here, the asset ownership is considered by the lessee and so asset appears on the balance sheet.

 

Aspects of Difference

Operating Lease Financial (Capital) Lease 

PURCHASE OPTION

In operating lease, the lessee does not have an option to buy the asset during the lease period. A financial lease allows the lessee to have a purchase option at less than the fair market value of the asset.

LEASE TERM

Lease term extends to less than 75% of the projected useful life of the leased asset. Lease term is generally the substantial economic life of the asset leased.

EXPENSES BORNE

Lessee pays only the monthly lease payment in operating lease. In a financial lease, lessee bears insurance, maintenance, and taxes.

TAX BENEFIT

Since operating lease is as good as renting, the lease payment is considered an expense. No depreciation can be claimed. The lessee can claim interest and depreciation both as a financial lease is treated as a loan.

RUNNING COST

In operating lease, no running or administration costs are borne by the lessee. For example, registration, repairs etc. since it gives only right to use the asset. In a financial lease, running cost and administration expenses are higher and are born by the lessee.

EXAMPLE

Normally, A Projector, Computers, Laptops, Coffee Dispensers etc Normally, Plant and Machinery, Land, Office Building etc

 

Difference between Operating and Financial Lease

Last updated on : September 14th, 2018

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