Difference between Financial and Operating Lease

Lease basically is of two types one is called financial lease and other is operating lease, let’s look at the differences between financial operating lease in order to get a better understanding about both financial and operating lease –

  1. While financial lease is a long term arrangement between the lessee (user of the asset) and the owner of the asset, whereas operating lease is a relatively short term arrangement between the lessee and the owner of asset.
  2. Under financial lease all expenses such as taxes, insurance are paid by the lessee while under operating lease all expenses are paid by the owner of the asset.
  3. The lease term under financial lease covers the entire economic life of the asset which is not the case under operating lease.
  4. Under financial lease the lessee cannot terminate or end the lease unless otherwise provided in the contract which is not the case with operating lease where lessee can end the lease anytime before expiration date of lease.
  5. While the rent which is paid by the lessee under financial lease is enough to fully amortize the asset, which is not the case under operating lease.
9 comments… add one
  • BANUPRASATH V

    very simple words

  • NANDHINI.S

    Hello sir!I have a doubt in which lease,the lessee can buy the asset? and will the lessee become the owner at the end of the lease period

    • naveed

      it is very simple in financial lease the hiring asset company can purchase the asset. lessee will be the owner after purchasing the asset.

  • BANU

    Easy to understand

  • maiquocquynh

    clearly understand

  • Anand

    Please tell me how both these lease affect the Balance Sheet. Do you get to claim depreciation in terms of financial lease? Can you claim the amount paid towards the financial lease as operating expense?

    • Ahmad

      Hi Anand. Only Finance lease affects the Balance sheet. The payments paid on Operating lease are shown in P & L account as an expense.

      1. Leased asset – Depreciation (Depreciation = Capital amount / Lease term)

      2. Current liabilities = Installment in Year 2 – Interest in year 2

      3. Long term liabilities = Total Installments – Total interest (Start from year 3 till the end of lease term)

      Hopefully you can understand it….

  • moitlamo omet phale

    It took me only 2minutes to understand this, whereas it tookme more than 5 lessons to understand it in class

  • Yagya

    Will you please clarify this with an example. For example A leases its land to B on which B constructs a building for 3000000 on condition that after 30 years the building will be property of A. B pays 100000 to A every rent every year. In this case who will claim depreciation ?
    regards
    yagya

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