Question

Distinguish between operating leases and financial leases. Would you be more likely to find an operating lease employed for a fleet of aircrafts or a manufacturing plant? Explain.

Answer 1

Differences between finance lease and operating lease are as below-

Finance lease	Operating lease
1. It is intermediate to long term arrangement	1. It is generally extended to economic life of an asset
2. Generally lease cannot be cancelled during the lease period	2. Lease can be cancelled during lease period
3. Lease is almost amortized during the lease period	3. Lease rental generally not sufficient to fully amortize the cost of the asset
4. Cost of maintenance, taxes, rent and taxes are to be borne by lessee unless otherwise provided	4. Cost of maintenance, rent and taxes are borne by lessor
5. Lessee bears risk of obsolescence of asset	5. Lessor bears risk of obsolescence of asset
6. Lessee is financier and not interested in asset	6. Lessor can recover cost of asset by sale

As it is clear from above points that in finance lease risk and rewards incident to asset in lease period are with lessee, however in operating lease, risk and rewards incident to asset are with lessor. In case of fleet of air-crafts, there is risk of obsolescence due to changing regulations and hence operating lease is more favorable for lessee. Also risk and rewards involved are on higher side which helps conclude that operating lease is more beneficial. In case of manufacturing plant lease, lease rentals can match economic life of an asset and hence it is more suitable for finance lease.