Leases

Question

Explain the key differences between operating and finance lease

simplejon · Answer

A finance lease (aka a capital lease) is often used to buy equipment for the major part of its useful life. At the end of the lease, the lessee obtains ownership of the equipment upon successfully purchasing the equipment. Contrast this with an operating lease agreement which an instrument to finance equipment for less than its useful life. Upon end of its life, the lessee returns the equipment without further obligation. Finance lease is often used to buy equipment for the major part of its useful life. There are some of the differentiating points between the 2 types of leases. First, title is transitioned to the lessee at end of the lease term for a finance lease. However, in an operating lease, ownership is retained by the lessor. Next, in a finance lease, there is a balloon or what we call an residual option for the lessee to purchase the property. This is often a bargain purchase agreement. Under an operating lease, the lessee doesn't have this option. Its as if they just rented the equipment. Lastly, the accounting treatment as very different. We treat operating leases as expenses and as such, do not show up in our balance sheet as assets. For finance leases, we assume temporary ownership and as such, the asset is included on their balance sheets. With new lease standards, operating leases will appear as liabilities on the balance sheet. Finance leases depreciate over time and incur interest expense. To be classified under US GAAP as a capital lease, 4 conditions must be met. First, a transfer of ownership at the end of the term. Second, the option to purchase at a discounted price. Third, the lease is greater than or equal to 75% of the useful of the asset. Lastly, the present value of lease payments is greater than or equal to 90% of the asset's fair market value.

Category:	Accounting
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Added:	24 May 2020, 04:19

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Added:	24 May 2020, 11:05
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Leases

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