Operating Lease

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Description of Operating Lease. Explanation.

 

Definition Operating Lease. Description.


Operating Lease does not transfer the risk or rewards of the leased property to the lessee in any economically substantial way. In an operating lease, the lessor (or owner) transfers only the right to use the property to the lessee. At the end of the lease period, the lessee returns the property to the lessor.


In accounting, operating leases are treated as Off-Balance Sheet Financing: an operating expense, and no asset or liability is recorded as part of the capital of the firm.


In the US, the Financial Accounting Standards Board has ruled that a lease should be treated as an operational lease if it meets none of the following four conditions:

  1. The lease life exceeds 75% of the life of the asset.

  2. There is a transfer of ownership to the lessee at the end of the lease term.

  3. There is an option to purchase the asset at a "bargain price" at the end of the lease term.

  4. The present value of the lease payments, discounted at an appropriate discount rate, exceeds 90% of the fair market value of the asset.


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