Difference Between Operating and Financial Lease

The differences between two basic forms of lease viz. operating lease and finance (capital) lease, are mainly related to who owns the leased asset, what accounting and tax treatment is given, who bears the expenses and running costs, whether a purchase option is present, and the length of the lease term.

Differences Between Financial (Capital) Vs. Operating Lease:

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

Aspects of DifferenceOperating LeaseFinancial (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 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.

Ownership

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.

Accounting Effect

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 like loan. Here, asset ownership is considered by the lessee, so the asset appears on the balance sheet.

 

Aspects of Difference

Operating LeaseFinancial (Capital) Lease 

PURCHASE OPTION

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.

LEASE TERM

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.

EXPENSES BORNE

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.

TAX BENEFIT

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.

RUNNING COST

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.

EXAMPLE

Projectors, Computers, Laptops, Coffee Dispensers, etc.Plant and Machinery, Land, Office Building, etc.

 

Difference between Operating and Financial Lease

Last updated on : April 25th, 2019
What’s your view on this? Share it in comments below.

10 Comments

  1. Avatar Sherli
    • Avatar Gopi raja
  2. Avatar neeraj
  3. Avatar Inderpreet Singh
  4. Avatar githu
  5. Avatar nana
  6. Sanjay Bulaki Borad Sanjay Bulaki Borad
  7. Avatar Agyare Benjamin
    • Avatar Alejandro
  8. Avatar Jessica

Leave a Reply