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    Differences Between Operating Lease and Finance Lease

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    tanya1780
    There are two main types of leases from the perspective of a lessee: operating leases and finance leases. With an operating lease, the leased asset is not reported on the balance sheet and rent payments are expensed. With a finance lease, the leased asset is capitalized on the balance sheet along with the corresponding liability. Finance leases also affect cash flows and financial ratios differently than operating leases due to the asset and liability recognition. Key differences include higher assets, liabilities, and debt ratios for finance leases versus lower for operating leases. Total cash flows and net income are the same over the lifetime of the lease for both types.

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    Differences Between Operating Lease and Finance Lease

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    tanya1780
    84 views2 pages
    There are two main types of leases from the perspective of a lessee: operating leases and finance leases. With an operating lease, the leased asset is not reported on the balance sheet and rent payments are expensed. With a finance lease, the leased asset is capitalized on the balance sheet along with the corresponding liability. Finance leases also affect cash flows and financial ratios differently than operating leases due to the asset and liability recognition. Key differences include higher assets, liabilities, and debt ratios for finance leases versus lower for operating leases. Total cash flows and net income are the same over the lifetime of the lease for both types.

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    There are two main types of leases from the perspective of a lessee: operating leases and finance leases. With an operating lease, the leased asset is not reported on the balance sheet and rent payments are expensed. With a finance lease, the leased asset is capitalized on the balance sheet along with the corresponding liability. Finance leases also affect cash flows and financial ratios differently than operating leases due to the asset and liability recognition. Key differences include higher assets, liabilities, and debt ratios for finance leases versus lower for operating leases. Total cash flows and net income are the same over the lifetime of the lease for both types.

    Copyright:

    © All Rights Reserved
    Download as DOCX, PDF, TXT or read online from Scribd
    Download as docx, pdf, or txt
    84 views2 pages

    Differences Between Operating Lease and Finance Lease

    Uploaded by

    tanya1780
    There are two main types of leases from the perspective of a lessee: operating leases and finance leases. With an operating lease, the leased asset is not reported on the balance sheet and rent payments are expensed. With a finance lease, the leased asset is capitalized on the balance sheet along with the corresponding liability. Finance leases also affect cash flows and financial ratios differently than operating leases due to the asset and liability recognition. Key differences include higher assets, liabilities, and debt ratios for finance leases versus lower for operating leases. Total cash flows and net income are the same over the lifetime of the lease for both types.

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    Download as docx, pdf, or txt
    of 2

    Differences between Operating lease and Finance lease

    Below is some info I have prepared while preparing for Level-1 CFA exam. Hope it helps you.
    Lessee perspective Lessor perspective
    Expense Expense over life time is same both.
    Reporting Operating Lease: Rent expense
    recognized in income statement. CFO
    affected
    Operating Lease: Lease payment
    recognized as Rental income.
    Asset is kept on B/S and depreciated
    over its life.
    Financial Lease: B/S effected. Over
    the term leased asset is depreciated.
    Payment split into interest (Goes into
    CFO) and principal (Goes into CFF)
    Interest may go into CFF also if IFRS
    Financial Lease: Treated as either sales
    type lease or direct financing lease
    Sales type(PV>CV) Treated as if asset
    is sold and loan is provided to buyer
    with same amount. Asset removed in
    beginning from B/S and lease
    receivable is created equal to the
    PV. Gross profit is recognized between
    PV and CV
    Direct financing(PV=CV): No gross
    profit recognized. Implies lessor simply
    financing asset. Here it implies as
    iflessor has bought asset from a third
    party. Asset removed in beginning from
    B/S and lease receivable is createdequal
    to the same amount.
    For both types, Principal is treated as
    CFI and interest portion as CFO




    Finance Lease

    Operating lease

    Assets

    Higher

    Lower

    Liabilities

    Higher

    Lower

    Net income(in early
    years)

    Lower

    Higher

    Net income(later years)

    Higher

    Lower

    Total Net income

    Same

    Same

    EBIT(o/p income)

    Higher

    Lower

    CFO

    Higher (because depreciation
    not considered in CFO).because only
    interest payments come here

    Lower

    CFF

    Lower

    Higher

    Total Cash Flow

    Same

    Same.

    CR (CA/CL)

    Lower

    Higher

    Working capital (CA-
    CL)

    Lower

    Higher

    Asset turnover (NI/TA)

    Lower

    Higher

    Return on assets

    Lower

    Higher

    D/E

    Higher

    Lower

    D/A

    Higher

    Lower

    Both in o/p and finance lease firms should disclose payments for the next 5 years seperately and
    cumulative amount of the next 5 years after that.

    In exam, check for these where you might make mistakes

    1. Check whether the payment is in beginning or the end of period while calculating leases. (This is
    same for TVM problems too). You do not need to discount the first payment if it is in the beginning of
    the period.
    2. Check the duration to determine if the lease is operating or finance lease
    3. In lease or bonds, we assume that we receive the interest rate on the amount issued at market
    rate. Hence it is the netter of interest rate we receive and the coupon amount we pay

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