Difference between Operating and Financial Lease

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

Difference Between Financial 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 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. In financial lease (Also known as capital lease), the risks and rewards related to ownership of asset leased are transferred to the lessee.
Ownership 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. 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. Financial lease is treated like loan generally. Here, the asset ownership is considered of the lessee and so asset appears on the balance sheet.
Purchase Option In operating lease, the lessee does not have any option to buy the asset during the lease period. 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 more than or equal to estimated economic life of the asset leased.
Expenses Borne Lessee pays only the monthly lease payment in operating lease. In financial lease, lessee bears insurance, maintenance and taxes.
Tax Benefit Since operating lease is as good as renting, lease payment is considered as expense. No depreciation can be claimed. Lessee can claim interest and depreciation both as financial lease is treated like a loan.
Running Cost In operating lease, no running or administration costs are to be borne 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.
Example Normally, A Projector, Computers, Laptops, Coffee Dispensers etc Normally, Plant and Machinery, Land, Office Building etc

Last updated on : August 31st, 2017
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