operating lease
rental of property between the lessee and lessor for a fee. An operating lease does not meet the criteria for a capital lease . An example is renting of an apartment or automobile. The lessee debits rental expense and credits cash. Rental expense should be recognized on a straight-line basis, unless another systematic and rational basis is more representative of the time pattern in which benefit use is derived. Thelessee shows nothing about the lease on the balance sheet. Lessee footnote disclosure includes future minimum lease payments in aggregate and for each of the five succeeding fiscal years, contingent rentals, and sublease rentals. The lessor, upon receipt of rental payments, debits cash and credits rental revenue. The lessor also records depreciation expense on the leased item and any expenses related to the leased property, such as maintenance expense. Normal accrual basis accounting techniques are followed for the recognition of income and expense. The lessor reports on his balance sheet the leased asset less accumulated depreciation. Footnote disclosure by the lessor includes the cost of property on lease or held for leasing by major class, minimum future rentals in the aggregate and for each of the five succeeding years, and contingent rentals.
See also sales type lease , direct financing lease operating lease
type of lease , normally involving equipment, whereby the contract is written for considerably less than the life of the equipment and the lessor handles all maintenance and servicing; also called service lease. Operating leases are the opposite of capital leases, where the lessee acquires essentially all the economic benefits and risks of ownership. Common examples of equipment financed with operating leases are office copiers, computers, automobiles, and trucks. Most operating leases are cancelable, meaning the lessee can return the equipment if it becomes obsolete or is no longer needed.
operating lease
lease written for a shorter period than the economic life of the leased asset. These leases ordinarily are written by equipment manufacturers, who are expected to take back the equipment and re-lease it to other users. Both commercial banks and finance companies write operating leases. Operating leases are cancelable leases, meaning the equipment can be returned at any time if it becomes obsolete or no longer is needed.
See also finance lease , residualvalue , leveraged lease , capital lease operating lease
type of lease , normally involving equipment, whereby the contract is written for considerably less than the life of the equipment and the lessor handles all maintenance and servicing; also called service lease. Operating leases are the opposite of capital lease , where the lessee acquires essentially all the economic benefits and risks of ownership.
operating lease
a lease between the lessee and the sublessee who actually occupies and uses the property.
Example: Figure 132.
See also sublease Related Terms:
accounting by lessor in which one or more of the four criteria required for a capital lease are met and both of the following criteria are satisfied: (1) collectibility of minimum lease payments is predictable and (2) no important uncertainties surround the amount of unreimbursable costs yet to be incurred. A sales type lease gives rise to a manufacturer's or dealer's profit or loss on the assumed sale of the item in the year of lease as well as interest income over the life of the lease. Lease payments receivable is recorded representing the minimum lease payments (net of amounts, if any, including executory costs with any profit thereon) plus the unguaranteed residual value accruing to the benefit of the lessor. The difference between lease payments receivable and the discounted value of the payments is recorded as unearned interest income. The discount rate used to determine the present value of lease payments is the lessor's implicit rate. Assume a sales type lease is entered into on 1/1/2004. Six year-end annual lease payments of $20,000 are to be received. The discount rate is 5%. The present value of an ordinary annuity for n = 6, i = 5% is 5.0757. The cost of the leased item is $85,000. Initial direct costs of the lease are $4000. Appropriate journal entries for 2004 and 2005 follow:
| 1/1/2004 |
|
| Receivable | 120,000 |
| Sales | 101,514 |
| Unearned Interest Revenue | 18,486 |
| $20,0007×5.0757 = 101,514 |
|
| Cost of Sales | 85,000 |
| Inventory | 85,000 |
| Direct Expenses | 4,000 |
| Cash | 4,000 |
| 12/31/2004 |
|
| Cash | 20,000 |
| Receivable | 20,000 |
| Unearned Interest Revenue | 5,076 |
| Interest Revenue | 5,076 |
| 5%×101,514 = 5076 |
|
| 12/31/2005 |
|
| Cash | 20,000 |
| Receivable | 20,000 |
| Unearned Interest Revenue | 4,330 |
| Interest Revenue | 4,330 |
5%× 86,590 = 4330
|
|
method used by lessors in capital leases when both of the following criteria for the lessor are satisfied: (1) collectibility of minimum lease payments is assured and (2) no important uncertainties surround the amount of unreimbursable costs yet to be incurred. In a direct financing lease, the lessor is not a manufacturer or dealer in the item; the lessor purchases the property only for the purpose of leasing it. The lessor uses the interest rate implicit in the lease to discount the future payments from the lessee. The difference between the gross investment in the lease and the cost of the leased property is reported as unearned interest income. Unearned interest income is then amortized using the interest method thus resulting in interest income over the life of the lease. Initial direct costs of the lease are expensed. sales type lease.
fixed-term lease, usually noncancellable, used by businesses in financing capital equipment. The lessor's service is limited to financing the asset, whereas the lessee pays all other costs, including maintenance and taxes, and has the option of purchasing the asset at the end of the lease for a nominal price. It is also called a full-payout lease because the lease is fully paid out (amortized) over its lifetime. Contrast with operating lease.
anticipated value or fair market value of an asset at the expiration of a lease. Fair market value is determined by agreement, or by appraisal. In an open-end lease, a consumer lease often used in auto financing, the lessee has the option of buying the car at its assumed residual value. Under Federal Reserve Regulation Y, bank holding companies are permitted to assume residual values not greater than 25% of an asset's acquisition cost.
- lease arrangement of property financed by someone other than the lessee or lessor. A long-term creditor finances the lease, and recourse in the event of default is generally not available to the creditor via the lessor.
- special lease arrangement involving a creditor, lessor, and lessee. A creditor finances most of the cost to acquire an asset, while the lessor puts in a small amount of cash and acquires the asset, using it as security. The asset is then leased to the lessee on a noncancellable basis, and periodic payments to the lessor service the debt. The lessor, having borrowed most of the funds to acquire the asset, has "leveraged" himself, while having both the rewards and the risks of the lease.
one in which the lessee obtains significant property rights. Although not legally a purchase, theoretical substance governs over legal form and requires that the leased property be recorded as an asset on the lessee's books. The asset equals the present value of minimum lease payments. A capital lease exists if any one of the following four criteria is met: (1) the lease transfers ownership of the property to the lessee at the end of the lease term; (2) a bargain purchase option exists; (3) lease term is 75% or more of the life of the property; (4) the present value of minimum lease payments equals or exceeds 90% of the fair value of the property.
agreement in which the lessee contracts with a third party allowing the latter to use the lessee's right to the leased property. An example is the sublease of an apartment by the tenant to another party. If the lessee accounts under the operating lease method, the sublessee would also account under this method.
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