CandleFocus

Operating Lease

Candlefocus Editor

An operating lease is a contract between two parties in which one (the lessee) rents an asset (the leased asset) from another (the lessor) for a predetermined amount of time. Under this type of agreement, the lessee has access to the leased asset for a specified amount of time and agrees to pay a set rental fee, which is typically charged on a periodic basis. Unlike a finance lease, however, an operating lease does not transfer ownership of the asset to the lessee.

Operating leases are popular among businesses, particularly those that require access to assets on a short-term basis. Such leases provide businesses with flexibility over the use and ownership of the asset, while also allowing them to avoid the capital expenditure associated with the purchase of a new asset. Operating leases generally turn over more quickly than finance leases, which tend to last a much longer period of time.

Under current Generally Accepted Accounting Principles (GAAP), which are generally accepted standards for financial reporting, operating leases are required to be recorded and reported on the balance sheet if they are 12 months or more in duration. For leases of a shorter duration, it is possible to recognize the rental payments as a period expense. This method is sometimes referred to as the "straight-line method", where the rental payments are evenly spread and recognized over the lease period.

Clearly, operating leases are a beneficial agreement for those who do not require ownership of an asset, or do not want to commit to a lengthy financial contract. Businesses can leverage the resources and utilize assets from a wide range of providers, without having to make a large financial outlay. Therefore, for short to medium-term projects, operating leases offer a number of clear advantages.

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