Wednesday, 18 January 2012

Finance vs Operating Lease

Finance Lease:
Finance Lease is the purchase of some asset by the buyer (lessee) that is directly financed by the seller (lessor). It is similar to purchasing the asset.

Operating Lease:
An Operating Lease is an agreement which lessee to use the asset for a period of time. It is similar to renting an asset.

Classification of Lease:
Under IFRS, if substantially all risks and rewards related to ownership are transferred to the lessee, the lease is classified as a finance lease and a lessee reports a leased asset and a lease liability on the balance sheet.

Under U.S. GAAP, a lease that meets any one of four specific requirements is classified as a finance lease.
The four requirements are as follows:

1) Ownership of the leased asset transfers to lessee at end of lease.
2) The lease contains an option for the lessee to purchase the leased asset at a price less than fair market value of the asset at some future date (also known as bargain purchase option).
3) The lease term is 75% or more of the useful life of the leased asset.
4) The PV of lease payments is 90% or more of the fair value of the leased asset.

NOTE: A lease  which does not meet any of these criteria is classified as an operating lease


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