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 two types of lease agreements.

operating lease agreements are those lease agreements which are used to finance equipments for less than the useful life of the Assets and Lessee can return equipment to the lessor at the end of the lease period without getting into any further obligation.

In the operating lease agreement, the ownership of the property is not transferred to the lessee and it is retained by the the lesser.

financing lease are lease agreements which are used to buy equipment for the majority of the part of the useful life and this will be leading to exchange of the ownership and the lessee will be obtaining the ownership of the equipment upon a successful offer to buy equipment and this is known as balloon payment.

Example of operating lease would be the lease to finance any asset which is lesser than the useful life and ownership will not be transferred.

Financial lease would be exampled through transfer of a machinery to the lessee and use of equipment for the majority of the life by lessee.

Accounting of of operating and financing leases will be different as as in financing lease risk and reward has been fully transferred and they are treated as capital lease and they are recorded on the books of the accounts of the lessee.

An Operating lease will be generally treated like renting it will mean that the lease payments are treated like operating expense and the Asset will not show in the balance sheet of the Lessee.