Distinction between Operating Lease and Finance Lease

Aspects of
Operating Lease Financial Lease
Difference
A lease in which all risks and rewards related to
In financial lease (Also known as
asset ownership remain with the lessor for the leased
capital lease), the risks and rewards
Definition asset is called operating lease. In this lease, the asset
related to ownership of asset leased
is returned by the lessee after using it for lease term
are transferred to the lessee.
agreed upon.
Ownership transfer option at the end
Ownership of the asset remains with the lessor for of the lease period is there with the
Ownership
the entire lease period. lessee. Title might or might not be
transferred eventually.
Operating lease is treated generally like renting. Financial lease is treated like loan
Accounting That means, the lease payments are treated as generally. Here, the asset ownership
Effect operating expenses and the asset does not show on is considered of the lessee and so
the balance sheet. asset appears on the balance sheet.
Financial lease allows the lessee to
Purchase In operating lease, the lessee does not have any
have a purchase option at less than
Option option to buy the asset during the lease period.
the fair market value of the asset.
Lease term is generally more than or
Lease term extends to less than 75% of the projected
Lease Term equal to estimated economic life of
useful life of the leased asset.
the asset leased.
Expenses Lessee pays only the monthly lease payment in In financial lease, lessee bears
Borne operating lease. insurance, maintenance and taxes.
Since operating lease is as good as renting, lease Lessee can claim interest and
Tax Benefit payment is considered as expense. No depreciation depreciation both as financial lease is
can be claimed. treated like a loan.
In operating lease, no running or administration
In a financial lease, running cost and
Running Cost costs are to be borne for example: registration,
administration expenses are higher.
repairs etc. since it gives only right to use the asset.
Normally, A Projector, Computers, Laptops, Coffee Normally, Plant and Machinery,
Example
Dispensers etc Land, Office Building etc