Question

Two common types of leases are operating and financing leases. In your own words, describe and share examples of each. What are the major differences in accounting for each of these two types of leases?

Answer 1

Operating lease and financial lease are generally two type of lease agreement under which property is transferred between the lessor and the Lessee.

Financial lease are lease agreements under which there is is an agreement to buy the equipment for the majority of the part of useful life of an equipment and it is leading to to exchange of the risk and reward and exchange of the ownership of the Asset and Lessee will be obtaining the ownership upon a successful offer to buy the equipment and this is known as balloon payment.

operating leases a type of lease agreement under which there is an agreement to finance equipment for lesser than the useful life of the Assets and Lessee can return the equipment to the lessor at the end of the lease period without getting the risk and the reward of that asset and ownership of the Asset and without any further obligations.

Operating leases can be example through lease period of two years or three years of a machinery and which will not be leading to transfer of the ownership upon completion of the lease period.

Financing lease would be referring to to 15 years of lease period after which the ownership of a machinery will be transferred to the lessee.

operating leases are generally treated like renting in the books of accounts and it will reflect that the lease payment are treated like operating expenses and assets will not be showing in the balance sheet of the lessee as the risk and reward has not been transferred.

Financial lease will mean that risk and reward have only been transferred into the books of accounts of the lessee and he can record the assets in his books and it will be treated like transfer of Asset.