Operating Lease

An operating lease is defined as a contract in which lessee is not committed to paying more than the original cost of the equipment during construal period.  The operating lease is a lease in which the term is short when compared to the economic life of the equipment or assets (a ship, an airliner, etc.) being leased. The operating lease is generally utilized to acquire assets or equipments on comparatively short-term basis. For instance, a ship that has 35 years of economic life could be leased to a shipping company for ten years on an operating lease.

The accounting for an operating lease is straightforward, since there is no transfer of ownership. The asset remains on the lessor's books and the lease is accounted for the same way rent is accounted for on the financial statements.   When an asset is leased, the lessor sets up a lease revenue account to record and account for payments received from the lessee, while the lessee sets up a lease expense account to record and account for lease payments.

Operating lease rentals are viewed as an annual expense of the business and should be charged to the income statement on a systematic basis (normally straight-line method) over the term of the lease. The accounting policies would normally state the policies. Rentals payable under the operating leases are posted on the income reports as incurred.

Property leases often give incentives to lessees to encourage uptake of leases, such as rental free periods and reverse premiums. Although no specific reference is made to these in the standard, the principle to be applied is straightforward and that is to charge the income statement on a straight-line basis over the term of lease. This ensures that the expense is charged and matched against the income that the asset generates while leased.

Questionnaire:

• What is operating lease?
• Give an example and explain operating lease?