What is Operating lease?
A contract that permits the use of an asset but does not convey ownership rights to the asset
An operating lease is a contract that permits the usage of an asset but does not grant ownership rights to the asset. These leases enable businesses to use an asset without incurring the high costs associated with purchasing it.
The lessee is the company that leases the asset, and the lessor is the company that leases the asset. The responsibilities of each party in the agreement are outlined in the lease contract and documents, but in general, the lessee is responsible for maintaining the asset to ensure it remains operational, less any normal wear and tear.
The operating lease’s features are:
- It provides equipment for a set duration. When a company does not require any machines or assets for an extended period, it may consider leasing them.
- When businesses need to replace assets, they choose an operating lease, especially when the industry is changing.
- When a company does not have any financial aid but wishes to continue normal operating activities, this lease can be used.
Historically, these kind of leases allowed American businesses to avoid recording billions of dollars in assets and liabilities on their balance sheets, allowing them to maintain low debt-to-equity ratios. This changed in 2016, with the publication of Accounting Standards Update 2016-02.
Operating leases are assets rented by a business in which ownership of the asset is not transferred at the end of the rental period. These assets typically include real estate, aircraft, and equipment with long useful lives, such as vehicles, office equipment, or industry-specific machinery.
It is essentially a contract in which a company agrees to use an asset and return it to the lessor in similar condition. This agreement is advantageous to the lessee, especially if the equipment is expensive.