What is the Difference Between Finance Lease and Operating Lease?

The main difference between a finance lease and an operating lease lies in the ownership and accounting treatment of the leased asset. Here are the key differences between the two types of leases:

1. Ownership: In a finance lease, the lessee takes ownership of the asset after the lease period is complete and the lessor meets all other contract obligations. In contrast, an operating lease does not transfer ownership rights to the lessee, and the lessor retains ownership of the asset throughout the lease term.
2. Accounting Treatment: Both finance and operating leases are recorded on the company's balance sheet as a right-of-use asset and a lease liability. However, finance leases are amortized over the life of the lease and have imputed interest, while operating lease expenses are recognized on a straight-line basis.
3. Risk and Benefits: In a finance lease, the lessee assumes all risks and benefits associated with the asset, while in an operating lease, the lessor retains all risks and benefits of the asset.
4. Lease Duration: Finance leases are typically long-term, while operating leases are generally short-term agreements.
5. Bargain Purchase Options: Finance leases often include options for the lessee to purchase the asset at the end of the lease term at a discounted price, while operating leases do not have such options.

In summary, a finance lease is more similar to a purchase of the underlying asset, with the lessee assuming ownership, risks, and benefits, while an operating lease is a short-term rental arrangement where the lessor retains ownership and control over the asset.

Comparative Table: Finance Lease vs Operating Lease

Here is a table comparing the differences between finance leases and operating leases:

Please note that the accounting treatment for finance and operating leases may vary slightly depending on the specific accounting standards being followed (e.g., IFRS or US GAAP).