The differences between two basic forms of lease viz. operating versus finance lease are mainly of ‘who owns the asset under the lease, what will be the accounting and tax treatment, who bears the expenses and running costs’. Please note that a finance lease and a capital lease are one and the same. We will be using these terms interchangeably.
Not only these, but operating versus finance lease also differ in whether a purchase option is present, and the length of the lease term.
Differences Between Financial (Capital) Vs. Operating Lease
The differences between financial and operating leases are as follows. These are explained with the help of the following table against various aspects of both operating and financial leases.
|Aspects of Difference||Operating Lease||Financial (Capital) Lease|
|A lease in which all risks and rewards related to asset ownership remain with the lessor for the leased asset is called an operating lease. In this type of lease, the asset is returned by the lessee after using it for the agreed-upon lease term. Read more about Operating Lease for in-depth coverage.||In a financial lease (also known as a capital lease), the risks and rewards related to ownership of the asset being leased are transferred to the lessee. Read this article on Finance Lease for more in-depth coverage.|
|The ownership of the asset remains with the lessor for the entire lease period.||The ownership transfer option at the end of the lease period is available to the lessee. The title may or may not be transferred eventually.|
|An operating lease is generally treated 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 generally treated as a loan. Here, asset ownership is considered by the lessee, so the asset appears on the balance sheet.|
Aspects of Difference
|Operating Lease||Financial (Capital) Lease|
|In an 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.|
|The lease term extends to less than 75% of the projected useful life of the leased asset.||The lease term is generally the substantial economic life of the asset leased.|
|The lessee pays only the monthly lease payment in an operating lease.||In a financial lease, the lessee bears the cost of insurance, maintenance, and taxes.|
|Since an operating lease is as good as renting, the lease payment is considered an expense. No depreciation can be claimed.||The lessee can claim both interest and depreciation, as a financial lease is treated as a loan.|
|In an operating lease, no running or administration costs are borne by the lessee, including registration, repairs, etc., since this lease gives only the right to use the asset.||In a financial lease, running costs and administration expenses are higher and are born by the lessee.|
|Projectors, Computers, Laptops, Coffee Dispensers, etc.||Plant and Machinery, Land, Office Building, etc.|
Quiz on Difference between Operating and Financial Lease
This quiz will help you to take a quick test of what you have read here.