Question

Compare and contrast two types of leases and describe the advantages and disadvantages of each. Which type of lease would produce the lowest risk?

Answer 1

Two types of leases are:
1. Capital Lease: It represents ownership and is often reflected on the company's balance sheet as an asset. This lease is a long-term arrangement and is non-cancellable. A capital lease, in contrast to an operating lease, is treated as a purchase from the standpoint of the person who is leasing and as a loan from the standpoint of the person who is offering the lease, for accounting purposes.
2. Operating Lease: Contrary to a capital lease, the period of operating lease is shorter and it is often cancellable at the option of the lessee with prior notice. Hence, operating lease is also called as an ‘Open end Lease'. It is often used for assets that are high-tech or in which the technology changes, like computer and office equipment.

In short note, An operating lease is treated like renting -- payments are considered operational expenses and the asset being leased stays off the balance sheet. In contrast, a capital lease is more like a loan; the asset is treated as being owned by the lessee so it stays on the balance sheet.

Operating Lease is less risky since the lessee is protected from the risk of obsolescence and also enjoys no risk at the cost of no ownership.

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