The Difference Between Financial Lease and Operating Lease
When it comes to leasing or renting equipment, there are two major options to consider: financial lease and operating lease. Both of these leasing options serve different purposes and come with varying benefits and disadvantages. In this article, we’ll take a closer look at the key differences between financial lease and operating lease.
What is a Financial Lease?
A financial lease, also known as a capital lease, is a long-term lease agreement where the lessee (the business or individual using the equipment) is responsible for most of the risks and benefits that come with owning the leased asset. In a financial lease arrangement, the lessee is responsible for all costs associated with the asset, such as repairs, maintenance, insurance, and taxes.
In a financial lease, the lessee has the option to purchase the equipment at the end of the lease term for a pre-determined amount that reflects the asset’s residual value. Financial leases are often used for expensive equipment that has a long lifespan, such as construction equipment or vehicles.
What is an Operating Lease?
An operating lease, also known as a service lease, is a lease agreement where the lessor (the company that owns the equipment) is responsible for the risks and benefits that come with owning the leased asset. In an operating lease arrangement, the lessor is responsible for all costs associated with the asset, such as repairs, maintenance, insurance, and taxes.
Operating leases are typically short-term leases, and at the end of the lease term, the lessee can usually either renew the lease, return the equipment, or upgrade to newer equipment. Operating leases are often used for equipment with a shorter lifespan, such as office equipment or technology devices.
The Main Differences Between Financial Lease and Operating Lease
One of the main differences between financial lease and operating lease is the length of the lease term. Financial leases are usually long-term agreements that last for several years, while operating leases are typically shorter-term agreements that last for a few months or a year.
Another key difference is the level of responsibility for costs related to the asset. In a financial lease, the lessee is responsible for all costs associated with the equipment, while in an operating lease, the lessor takes care of these costs.
Finally, financial leases often offer a purchase option at the end of the lease term, while operating leases typically do not. This means that in a financial lease, the lessee has the opportunity to own the equipment at the end of the lease term, while in an operating lease, the lessee typically returns the equipment or upgrades to newer equipment.
In conclusion, both financial lease and operating lease have their own unique advantages and disadvantages, and what works best for your business or personal needs will depend on the type of equipment you need, how long you need it for, and your financial situation. Be sure to consult with a leasing expert to determine which leasing option is right for you.
Table difference between financial lease and operating lease
| Aspect | Financial Lease | Operating Lease |
|---|---|---|
| Ownership | Lessee has ownership | Lessor retains ownership |
| Term | Long-term (majority of asset’s useful life) | Short-term (less than asset’s useful life) |
| Asset Maintenance and Repairs | Lessee is responsible | Lessor is responsible |
| End of Lease | Lessee has option to buy asset at end of lease | Lessee returns asset or can renew lease |
| Income Statement Impact | Cost of lease is recorded as interest expense and depreciation | Lease expense is recorded as operating expense |
| Balance Sheet Impact | Asset and liability are recorded on balance sheet | Only liability is recorded on balance sheet |