Operating Lease

An operating lease is a lease whose term is short compared to the useful life of the asset or piece of equipment (an airliner, a ship, etc.) being leased. An operating lease is commonly used to acquire equipment on a relatively short-term basis. Thus, for example, an aircraft which has an economic life of 25 years may be leased to an airline for 5 years on an operating lease.

The determination of whether a lease is a finance (also called capital) lease or an operating lease is defined in the United States by Statement of Financial Accounting Standards No. 13 (FAS 13). In countries covered by International Financial Reporting Standards, the tests are defined in IAS 17. In July 2006, the FASB and the International Accounting Standards Board (IASB) announced the commencement of a joint project to comprehensively reconsider lease accounting. In July 2008, the boards decided to defer any changes to lessor accounting, while continuing with the project for lessee accounting, with the stated intention to recognise an asset and obligation for all lessee leases (in essence, eliminating operating lease accounting). The projected completion of the project is now 2011.

In the context of cars and other passenger vehicles, under an operating lease the lessor leases the vehicle to the lessee for a fixed monthly amount, and also assumes the residual value risk of the vehicle. This provides a way to lease a vehicle where the cost of the vehicle is known in advance – however, operating leases can be an expensive option as there is a risk premium priced into the monthly payments.

Operating lease has also spread to industrial equipment. The lessor leases the equipment to the lessee which pays periodically a rent. Operating lease is the smartest way for the outsourcing of industrial equipment. It allows the company not to use its equity in a investment that produces no direct added value, but to dedicate it to its core business and valuation.

Unlike a Financial Lease or Finance lease, at the end of the operating lease the title to the asset does not pass to the lessee, but remains with the lessor. Accordingly, at the end of an operating lease, the lessee has several possibilities:

• Pursuit of the lease
• Return of the equipment
• Renewal of equipment
• Restoration of equipment
• Purchase of equipment at their market value

The main advantages of operating lease are:

• No incidence of the rents on the balance sheet: they are operating expenses deductible from profits.
• Improvement of cash-flow
• Economy of corporate taxes