Difference between Operating Lease and Financial Lease

Difference between operating and financial lease are:

Operating Lease

  • Definition: A lease in while 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.
  • Ownership: Ownership of the asset remains with the lessor for the entire lease period.
  • 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.
  • Purchase Option: In operating lease, the lessee does not have an option to buy the asset during the lease period.
  • Lease Term: Lease term extends to less than 75% of the projected useful life of the leased asset.
  • 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.

Financial Lease

  • Definition: In financial lease (Also known as a capital lease), the risks and rewards related to ownership of asset leased are transferred to the lessee.
  • Ownership: 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: Financial lease is treated like loan generally. Here, the asset ownership is considered by the lessee and so asset appears on the balance sheet.
  • Purchase Option: Financial lease allows the lessee to have a purchase option at less than the fair market value of the asset.
  • Lease Term:  Lease term is generally more than or equal to the estimated economic life of the asset leased.
  • Running Cost: In a financial lease, running cost and administration expenses are higher.