Operating Lease in Business

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Finance companies are often associated with finance leases but they also fund large operating leases. Many airlines have use of aircraft through operating leases through finance companies. Hire companies These companies own a stock of capital assets which they will lease out for varying periods. They include:

 tool hire companies;

 plant hire companies; and

 car hire companies. Hire companies are usually involved in operating leases. Manufacturer/dealer lessors Some companies make or buy assets to sell.

They may offer to lease the asset out as an alternative to outright sale. Many motor vehicle manufacturers and dealers do this. Such leases would usually be finance leases (but not necessarily)

Property companies Many companies own properties which they lease out to others. These companies might apply IAS 40: Investment Properties to these assets

Finance lease: A lease that transfers substantially all the risks and rewards incidental to ownership of an underlying asset. Operating lease: A lease that does not transfer substantially all the risks and rewards incidental to ownership of an underlying asset.

A lease is classified as a finance lease if it transfers substantially all the risks and rewards incidental to ownership. A lease is classified as an operating lease if it does not transfer substantially all the risks and rewards incidental to ownership.

 

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Risks may be represented by the possibility of losses from:

 idle capacity;  technological obsolescence;

 variations in return caused by changes in economic conditions. Rewards may be represented by the expectation of;

 profitable use of the asset over its economic life;  gains from increases in value or profits on disposal. Substance over form Whether a lease is a finance lease or an operating lease depends on the substance of the transaction rather than the form of the contract.

The legal form of a finance lease is that the lessor is the legal owner of the leased asset.

 

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The economic substance of a finance lease is that the lessee has all the benefits and costs associated with ownership of the asset.

The finance lessee is in the same position as it would have been if it had borrowed money to buy the asset itself. That is why such leases are called finance leases; they provide finance for the use of an asset.

At the end of the term of the lease, the legal ownership of the asset will be transferred from the lessor to the lessee, under the terms of the lease agreement;

The term of the lease is for a major part of the expected economic life of the asset;

 

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The lessee has the option, at a future date, to purchase the asset from the lessor, and the agreed purchase price is substantially lower than the expected fair value of the asset at the date the option to buy can be exercised. (In this situation, it is therefore probable that the lessee will exercise the option to buy the asset);

At the inception of the lease, the present value of all the future lease payments amounts to substantially all of the fair value of the leased asset, or more;

The leased asset is of such a specialised nature that it can only be used by the lessee (without the need for a major modification)