Dec. 28, 2021, midnight

From the company's perspective, the decision on the type of lease to obtain has a significant impact on operational efficiency in terms of profit and loss. It must be borne in mind that the decision that can be taken in this regard may vary depending on the circumstances and differences specific to the industry. In this article, we will discuss this topic in detail:

Financial lease, or otherwise known as capital lease, where the owner of the asset allows the benefit of the asset for an agreed period of time. Here the legal company that owns the asset is referred to as the lessor, and the user of the asset is known as the lessee.

Here, operational control of the asset rests with the lessee, and the entire responsibility in terms of risks and rewards associated with ownership of the asset rests with the lessee. As a result, the lessee will record the asset as a fixed asset in its contracts and record the interest from lease payments as an expense.

As for an operating lease, this type of contract allows the lessor to use the asset but does not retain ownership rights to the asset. These types of leases are considered a form of off-balance-sheet financing. Unlike a finance lease, an operating lease means that the leased asset and its associated obligations such as rent, or interest payments are not included in the lessee's balance sheet. It should be noted that there are certain requirements and criteria that must be met for an operating lease not to be classified as a finance lease.

Operating lease can broadly be considered a lease, i.e., lease payments are an operating expense with the leased assets not recorded on the company's balance sheet as they are spent on the income statement. On the other hand, a finance lease is very similar to a long-term loan or property. The asset is treated as owned by the lessee (for the duration of the agreement or contract) and is recorded in the balance sheet. Finance leases can be considered debt, as their value depreciates over time and interest expense is incurred. One thing that both types of lease have in common is that the lessor gives the lessee the authority to use the asset and return it at the end of a pre-agreed period of time.

After reviewing the concept of finance lease and operating lease in detail, determining which is better is summarized in the conditions and scenarios specific to the industry as mentioned earlier. An operating lease is usually suitable for companies that do not prefer or are not able to handle the associated administrative obligations when it comes to asset maintenance. They are usually an ideal choice for companies that do not want or do not need to show their assets on their balance sheet. On the other hand, finance leases are ideal for companies that want to purchase assets without committing to large upfront costs.

Understanding the differences between financial leasing and operating leasing is essential. The demands of each organization are different, and a complete understanding and awareness of the demands and risks associated with both types of leasing will greatly help in determining the most appropriate option for each company, whether you are the renter or the lessor.