(b) Key differences between operating and finance leases
Finance lease
A finance lease is an agreement between the user of the leased asset and a provider of finance that
covers the majority of the asset's useful life.
Key features of a finance lease
(i) The provider of finance is usually a third party finance house and not the original provider of
the equipment.
(ii) The lessee is responsible for the upkeep, servicing and maintenance of the asset.
(iii) The lease has a primary period, which covers all or most of the useful economic life of the
asset. At the end of the primary period the lessor would not be able to lease the equipment to
someone else because it would be worn out.
(iv) It is common at the end of the primary period to allow the lessee to continue to lease the asset
for an indefinite secondary period, in return for a very low nominal rent, sometimes known as
a 'peppercorn' rent.
(v) The lessee bears most of the risks and rewards and so the asset is shown on the lessee's
balance sheet.
Operating leases are rental agreements between a lessor and a lessee
Key features of an operating lease
(i) The lessor supplies the equipment to the lessee.
(ii) The lessor is responsible for the upkeep, servicing and maintenance of the asset.
(iii) The lease period is fairly short, less than the expected economic life of the asset. At the end
of one lease agreement the lessor can either lease the same equipment to someone else and
obtain a rent for it or sell it second-hand.
(iv) The asset is not shown on the lessee's balance sheet. |
