Meaning and definition of Operating Lease
Operating lease is, basically, a lease contract which allows the use of an asset, but rights similar to asset’s ownership are not conveyed. According to Investopedia, an operating lease is not capitalized. It is, rather, accounted for as a rental expense. Explaining in simple words, an operating lease is a lease which features a short term as compared to the useful life of the asset or equipment which is being leased. Generally, an operating lease is used for acquiring equipment on comparatively short-term basis.
At the closing stages of an operating lease, there are several possibilities with a lesse:
- Lease pursuit
- Equipments’ renewal
- Equipments’ restoration
- Purchasing equipments at the market value
Advantages of an Operating Lease
An operating lease features both advantages and disadvantages. Operating lease is used to hide financially leveraged balance sheets by presenting capital leases as operating leases. Although an operating lease is, many a times, more expensive as compared to an outright purchase or a capital lease for the same equipment due to the guarantee of service obscured in an operating lease in addition to the obsolescence risk assumed by the leasing company. However, this is justified by the lessee through the convenience of relying on fully operational equipment in addition to avoiding the obsolescence cost.
Moreover, this cannot always be the case as the maintenance cost of a highly specialized leasing company can be much less as compared to that of the user firm. Similarly, the leasing company can also serve distinctive client markets, those requiring the latest technology as well as the ones who prefer to pay less for comparatively slower equipment.
Also, the leasing company is capable of managing the cost of obsolescence in an efficient way as compared to any lessee, especially in case of higher technology equipment like computers and copying machines. Adding more to the point, an operating lease reduces the financial risk for being cancellable. Moreover, an operating lease reduces the lessee’s liabilities thus allowing it to borrow more than if it used a mortgaged loan or a capital lease.